Observations and Insight

A Swiss Surprise
Doug Ashburn – John Lothian News

Today’s newsletter is full of volatility stories from yesterday’s surprise move by the Swiss National Bank, which, while we were sleeping Thursday morning, abandoned the 1.20 floor to the euro (EUR/CHF), and the currency skyrocketed 25 percent at one point versus the dollar. Talk about a flash crash. To put it in perspective, that would be about a 4300 point move in the Dow Jones Industrial Average.

Five years ago I left the CME, where I had traded FX options for about 20 years, mostly in the Swiss franc. Had I not left, Thursday would have been my last day, one way or the other. Options market makers tend to hold fairly sizable positions, sometimes by choice, but often because our job is to take the other side of what the market demands. In a pinch, I would have hedged positions in the euro, which correlated strongly even before the SNB floor was put in place a few years ago. I would have awoken Thursday morning to find myself either fabulously wealthy or out of business. Either way, it would have been au revoir, auf wiedersehen, goodbye.

Of course, it was not just the nominal move that rocked the FX world, but also the volatility spike. The long term average volatility during my 20 years trading the Swissie was about 10.5 percent. During last year’s doldrums, vol reached the mid-single digits. Yesterday the front month settled at around 50 percent. Even the back month straddles doubled overnight. Imagine that.

Lead Stories

Traders With 5 Billion Euros in Put Options Hit Jackpot on Franc
Anchalee Worrachate and Vassilis Karamanis – BloombergBusinessweek
When the Swiss National Bank decided to remove its cap on the franc today, it handed a winning lottery ticket to some traders of currency options.
Almost 5 billion euros ($5.8 billion) notional of options to sell the euro against the franc at less than 1.20 per euro were registered with the Depository Trust & Clearing Corp. since Oct. 15 and were still outstanding today. Those trades, which depended on the cap being breached or removed to be profitable, would make money based on the current exchange rate.
***SR: “Some” traders of currency options made money. Some did not.

Swiss Stocks Blindside Traders as Volatility Soars 70%: Options
Sofia Horta e Costa and Namitha Jagadeesh – Bloomberg
If anyone saw Switzerland’s central bank coming, they didn’t do much about it in the options market.
A contract that paid out should the benchmark Swiss Market Index (SMI) drop to 8,150 by today from around 9,200 had no volume for the last week. That changed yesterday, when the Swiss National Bank’s move to abandon its currency peg against the euro sent shock waves through markets. A rout in Swiss equities spurred traders to snap up 4,300 of the puts in a matter of hours, sending the price soaring from a few centimes to more than 15 francs — a jump of about 15,000 percent.

Fallout From Swiss Move Hits Banks, Brokers
Anjani Trivedi, Tommy Stubbington, David Enrich and Katie Martin – WSJ
For Deutsche Bank and Barclays, the losses stemmed at least in part from their traders’ portfolios of options tied to the Swiss franc, according to traders and other banking officials. The value of those options is directly tied to the level of market volatility and the Swiss franc exchange rate. The sudden change in those two factors caused immediate losses for the banks, these people said. While representing large single-day losses, they are unlikely to have a major long-term impact on either bank.
***SR: The big news today, the Swiss franc fallout left the retail forex broker FXCM with a negative equity balance of about $225 million.

Traders Look for Bright Side in Trillion-Dollar Selloff
Callie Bost – Bloomberg
Investors are in a desperate search for good news amid the wildest stock swings in two years.
Almost $1 trillion has been erased from U.S. shares in the worst start to a year since 2009, with the Standard & Poor’s 500 Index (VIX)’s 0.9 percent slide today marking its fifth straight decline. Intraday lurches have become the norm as concern about plunging oil and rallying Treasuries plagues traders.

Fear of Fear Itself Reaches Crisis Levels
ETF Trends
Franklin Delano Roosevelt would be disappointed. The US fear index, officially named the CBOE Volatility Index (VIX), has ticked up, averaging 16.4 since the beginning of Q4 2014, compared to 13.5 in the first three quarters of last year. If the story stopped there, we might still be able to look FDR in the eye. But we are in an even worse condition. Contrary to his advice, we are fearing “fear itself,” and doing so at levels typical of major crises, including the financial meltdown of 2008.
How do we know we are this anxious? The “VVIX” tells. The VVIX is an index that measures the volatility of VIX – in other words, the volatility of volatility.
***DA: The only thing we have to fear is fear of fear itself.

This Is How Markets Behave Before They Crash
Michael T. Snyder – Investing.com
When the stock market starts to behave like a roller coaster, that is a sign that a major move to the downside is right around the corner. As I have stated repeatedly, when the market is very calm it tends to go up. But when the waters start getting really choppy, that is a clear indication that stocks are about to plummet. In early 2015, volatility has returned to Wall Street in a big way. At one point on Tuesday, the Dow was up more than 300 points. But then the bottom dropped out.
***DA: Plenty of head fakes, mini-corrections and new highs before the NASDAQ finally toppled over in 2000.

The Bond Market Is Warning of Huge Trouble Ahead
Anthony Mirhaydari – The Fiscal Times
Something odd is happening in the government bond market: Interest rates are pricing in a debt-deflation cataclysm.
How else can you explain the fact that the yield on the U.S. 30-year bond hit a record low of 2.4 percent on Wednesday? Or that Japanese and German 10-year yields are plumbing record lows? Or that five-year yields of bonds issued by Eurozone safe havens Finland, Germany and Switzerland are in outright negative territory?
Something is very wrong here.

Stocks have dropped enough to turn one technician ‘all out’ bullish
Tomi Kilgore – MarketWatch
The stock market has fallen so far to start the year that one chart watcher is set to turn “all out bullish.”
Tom McClellan, who publishes the widely-read McClellan Market Report, has been calling for the stock market’s latest pullback to end some time this week, if it fell enough to cause an oversold condition. After the S&P 500 SPX, +0.60%   slumped as much as 1.7% in intraday trade Wednesday, before closing down just 0.6%, he said he would “change to all out bullish if Thursday is a down day.”

Levine on Wall Street: FX Fallout and the Value of Volatility
Matt Levine – Bloomberg
So … how’s your foreign-exchange trading going? Yesterday’s pick-a-number-standard-deviation move in the Swiss franc “caught everyone off guard,” “sent the markets into a tailspin,” is “likely to create more volatility in the short term,” and left a lot of people very embarrassed or broke:

Financial TV, Target (Not) In Canada, NFL Odds, and More
Adam Warner – Schaeffer’s Investment Research
Anyone mentally exhausted from this week’s market action? We all complain when volatility looks like wallpaper, but hey, I miss those days! More fun to watch stocks grind up then crumble down.
Anyway, some random Friday thoughts:

Indexing Innovation: Launching ETFs to the Next Level
Tom Lydon – ETF Trends
Smart- or strategic-beta indices are rapidly gaining traction in the exchange traded fund industry as investors turn to alternative indexing methodologies that employ actively managed investment styles in a passive and relatively cheap fund wrapper.
On the upcoming annual ETF Virtual Summit, an online conference experience hosted by ETF Trends and RIA Database on January 21, financial advisors will hear from industry experts on benchmark construction, the advantages of smart beta indexes and what we should expect in 2015.

Data-driven ‘quant’ hedge-fund firms such as Paris-based CFM make a comeback
Jeremy Kahn and Lindsay Fortado – The Washington Post
Paris is famous as the home of philosophers, scientists and mathematicians. Today, thousands of students traipse through the city’s Left Bank on their way to classes at the Universite Pierre et Marie Curie and the Ecole Normale Superieure.
Those schools are one reason Capital Fund Management has its offices there, in a modernized 17th-century building. CFM, a quantitative hedge-fund firm that bases its trading strategies on computer-driven statistical models, has always plucked its staff from the ranks of the local schools’ math and physics departments.


Hong Kong Exchange Proposes Reintroducing Closing Stock Auction
Kana Nishizawa – BloombergBusinessweek
“The reintroduction of the closing auction will be welcomed by all investors,” Brett McGonegal, chief executive officer of Reorient Group Ltd., said by e-mail. “In Hong Kong, risk and options traders have found the closing price an elusive moving target. This is good news and allows Hong Kong to upgrade its profile and offering.”

BGC raises bid for GFI Group to counter CME offer
Ciara Linnane – MarketWatch
BGC Partners Inc. on Thursday raised its bid for GFI Group Inc. saying it is now offering a contingent increase of its all-cash tender to $5.85 a share, or an immediate non-contingent increase to $5.75 a share.
***SR: BGC and CME keep batting the ball back and forth.

ICE Futures Europe Sets Daily Volume Record in Three Month Euro Swiss Franc Futures
Press Release – ICE
Intercontinental Exchange, the leading global network of exchanges and clearing houses, today announced that ICE Futures Europe reached a daily volume record of 199,692 contracts in Three Month Euro Swiss Franc (Euroswiss) futures on January 15, 2015. The previous record of 194,340 contracts was set on December 4, 2012.
The record volume in the ICE Futures Europe Euroswiss futures contracts follows yesterday’s announcement by the Swiss National Bank to cut the deposit rate to -0.75% and abandon the cap on the Euro/Swiss Franc exchange rate.
Year to date, Euroswiss futures have recorded an average daily volume of 42,945 contracts, up 168% compared to the same period of 2014. Open interest currently stands at 265,191 contracts as of January 14, 2015, up 30% on 2014.

Euronext to launch revamped dairy derivatives by end-March
Gus Trompiz – Reuters
Euronext’s new dairy derivatives, announced in November, are scheduled for launch on its Amsterdam derivatives market at the end of the first quarter, it said on Friday.
The exchange operator had previously indicated that it was aiming to launch the euro-denominated dairy futures and options in the spring, without specifying where they would be listed.


Options on Greece ETF draw bearish bets ahead of election
Saqib Iqbal Ahmed – Reuters
Political turmoil in Greece has hit its financial markets hard, and traders in the U.S. options market are positioning for a further fall in Greek stocks as the country heads to a snap election that could determine whether it leaves the euro zone.
There are few choices for investors who want narrow exposure to Greece in U.S. markets, but one, the Global X FTSE Greece 20 exchange traded fund, which tracks the Greek equity market, has seen more active trading in the options market as traders position for more upheaval.

Block Trade – Deep OTM RUT Put Spread from 1/14
Russell Rhoads – CBOE Options Hub
I know this is a bit dated, but looking at Wednesday’s block trades something stood out to me in the Russell 2000 Index (RUT) option arena. A large (over 20,000 contracts) block trade went off in the RUT Jan 23rd 1060 and RUT Jan 23rd 1070 Puts. The trade was a far out of the money bull put spread with the RUT Jan 23rd 1070 Puts being sold for 1.15 and the RUT Jan 23rd 1060 Puts being purchased for 1.00 and a net credit of 0.15. As will all vertical credit spreads the maximum profit for this trade is the 0.15 taken in when the trade was initiated. The potential loss is 9.85 if the Russell 2000 drops to 1060 or lower by next Friday. This is shown in the payoff diagram below which also highlights where the Russell 2000 closed on Wednesday (1177).

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