Observations & Insight

AFX Bell Ringing
American Financial Exchange (AFX) Goes Live
The American Financial Exchange went live at 8:30 am on Friday at a special bell ringing ceremony at the Chicago Board Options Exchange
The market, created by Dr. Richard Sandor and operated by the CBOE, is designed to allow small and midsized banks to lend and borrow short-term funds. Six banks have already signed up to participate.
JLN interviewed Dr. Sandor back in September and he spoke about the AFX in a video, which you can see here.


New Captain: SGX’s Boon Chye Navigates Tough Asian Markets
Jim Kharouf – JLN

Loh Boon Chye took the reins as CEO of Singapore Exchanges (SGX) in July. A former SGX board member and Bank of America Merrill Lynch’s deputy president and head of global markets in Asia Pacific, he said there is much opportunity for the exchange to grow, and perhaps even benefit from the competition that has moved in around him from ICE and others. Boon Chye spoke at SGX’s headquarters with JLN Editor-in-Chief Jim Kharouf about his management style, the game plan for the exchange going forward and just where SGX fits in the global market landscape.

Q: You took the CEO position in July at SGX. How did you go about setting your priorities as a CEO and for SGX?

A: My philosophy is, you have to listen first, then you have to engage, observe, take feedback. I know some CEOs like to come out with a grand plan after 90 days, but frankly with any new CEO in any organization, how much can you know in 90 days? No doubt I had the benefit of being on the board, but that is different than being in management. So I took the time to listen, engage and interact, not just internally but externally with stakeholders.

Read the rest of Kharouf’s interview with Loh Boon Chye at JohnLothianNews.com

Lead Stories

Wild Markets Seen No Barrier This Time to Unstoppable Fed
Jonathan Burgos – Bloomberg
Once again, the Federal Reserve is about to make a historic interest-rate decision against a backdrop of rising equity volatility, tumbling commodity prices and jitters in credit markets. This time, investors expect policy makers to pull the trigger.
Janet Yellen has been preparing financial markets for a rates liftoff this week as evidence grows that the U.S. economy is strong enough to weather tighter monetary policy. Many market watchers were taken by surprise when the Fed held off at their September meeting, even in the wake of the first correction in the Standard & Poor’s 500 Index in four years.

The VIX Is Used as a Hedge for High-Yield Debt; That’s Why It’s Overbought
Mark Sebastian – The Street
Friday was an absolutely crazy day for every market, except for equities. Anyone who is active in the financial markets understands that there is a liquidity issue and a pricing issue on high-yield debt, especially as it’s related to oil and gas companies, which have a lot of leverage and a now inexpensive product (one thing to remember, the solution to high prices is always high prices, and the solution to low prices is low prices … not a bunch of regulation).

Extreme Fear? The VIX Says Not Yet
Steve Sears – Barron’s
Everything stock investors need to know about the VIX is contained in this phrase: When VIX is high, it’s time to buy. When VIX is low, it’s time to go. The phrase simply means that investors should buy stocks when VIX is high, and sell stocks when investors are confident about stocks. After all, the CBOE Volatility Index surges when stocks decline, and declines when stocks surge. This makes it a valuable sentiment indicator.

Prepare For More Volatility Ahead: MKM
Teresa Rivas – Barron’s
There’s been a transition underway in markets since big selloffs in August, a “a structural shift into a high volatility regime for U.S. equities,” according to MKM Partners’ Jim Strugger.
Strugger calls this an “inflection time” in a new note, arguing that developments in the volatility cycle fit with the firm’s economist’s view that the U.S. economic expansion could end over the next 18 months. This shouldn’t surprise investors, Strugger writes, as there’s an established correlation between volatility, economic and credit cycles and offsets:

When VIX Hits ‘Maximum Turbo’
Adam Warner – Schaeffer’s Investment Research
Well, so much for Churn Central. We’re now officially into “The Wall of Worry: Credit Markets Edition.” The market is pretty much daring the Fed to hike into this. I’m guessing a hike is still treated better than inaction, but clearly the equation is changing.
Anyways, it was quite the eventful week in CBOE Volatility Index (VIX)-land. Our favorite fear gauge popped 65%, thanks to a huge 3.7% drop in the markets.
Wait, what? That’s kind of extreme, right?

Buckle up: The first of three pieces on the Federal Reserve’s imminent interest-rate decision looks at whether America is ready for lift-off
The Economist
SINCE interest rates hit rock-bottom in 2009, the Federal Reserve has repeatedly made optimistic forecasts about when they would start rising, only to delay the big day again and again. If the Fed has been a bullish coach, the markets have been trusting fans, continually believing that an increase is imminent, only to have their expectations dashed. At last, however, the moment seems to have arrived. On December 16th, when the Fed’s rate-setting committee meets, it seems all but certain to raise rates.

Five Mind-Blowing Stats from the Selloff in the Biggest Junk Bond ETF
Eric Balchunas – Bloomberg
The world’s largest junk bond exchange-traded fund had one hell of a day last week, after the closure of a Third Avenue bond mutual fund sparked a wider sell-off in the credit market.
If Friday was a test, then the fixed income ETF experiment appears to be working, although the stakes keep getting raised. The experiment involves taking a prehistoric, over-the-counter market like bonds and trying to bring them into the modern world with a lightning-speed, equity-trading vehicle like an ETF. Some think this is a permanent evolution that we all should praise while others see a Jurassic Park-esque disaster waiting to happen.

Goldman Gets 7 Out of 8 Right for the Economy in 2015 – Income Investing
Amey Stone – Barron’s
At about this time last year, economists at Goldman Sachs published eight questions for 2015 and then answered them. On Friday, they tally up how they did on their predictions.
Pretty darn well, it turns out.
The only got one wrong: “Will the housing recovery accelerate?” They thought it would, but it didn’t. They write Friday:

Volatility the surest bet in stocks after Fed meets
Saqib Iqbal Ahmed and Rodrigo Campos – Reuters
Stock market investors are ready for the first U.S. Federal Reserve interest rate hike in nearly a decade next week, but they may not be fully prepared for all of the nuanced remarks likely to accompany that announcement.
If the Fed lays out an aggressive schedule of future rate increases, stock markets could become very volatile and even plummet, say strategists who expect a market-calming central bank announcement detailing the patience of policymakers.

Year’s best fund focuses on shorting ‘poorly designed’ ETFs
David Randall – Reuters
In a year that is shaping up to be the worst for hedge funds since at least 2011, one little-known long-short mutual fund manager is beating some of Wall Street’s biggest names at their own game.
David Miller, 35, is doing so largely by using options to short leveraged exchange traded funds which are ETFs that offer two or three times the daily positive or negative return of an index and which have become increasingly popular among hedge funds and other traders as the broad U.S. market has flatlined. Leveraged ETFs have seen inflows of $9.5 billion this year, according to Lipper data.

Here’s Why Markets Saw a Slowdown on Friday
Mohammad Shehmir – Business Finance News
Friday saw a volatile trading session across markets due to certain macroeconomic factors. The three major US stock indices slid down, primarily due to an impending rate hike decision by Fed, oil maintaining a downward trend (hitting lowest in seven years), and major sell off of junk bonds. Dow, NASDAQ, and S&P saw a decline on Friday. Dow went down 309.54 points (1.76%), the NASDAQ plunged 111.71 points (2.21%), and the S&P slipped 39.86 points i.e. 1.94%. On the other hand, VIX volatility index went up 26% by 24.39 points, signifying an increased risk in the market.

Junk Rated Stocks Flashing Same Signal as High-Yield Bond Market
Lu Wang – Bloomberg
Think equity investors have been blind to warning signs coming from junk bonds? Not quite.
For most of the year pessimists have warned that equity markets were missing signals in high-yield credit, where losses snowballed even as gauges like the Standard & Poor’s 500 Index remained relatively stable. While true, most of that is an illusion of index composition — not evidence of complacency.


Trade Volumes Up For CME Across Key Asset Classes in November
CME Group witnessed four consecutive quarters of growth in trading activity in 2014. The growth spree continued through the first three quarters of this year, with average daily volumes increasing by an aggregated 7% on an annual basis to 14.2 million contracts per day. This resulted in its transactions and clearing fee revenues growing by 11% y-o-y to $2.1 billion for the same period. Keeping up the trend for the year – except the months of September and October when volumes dipped – CME Group reported its November volumes were up by 6% y-o-y, to an average of 13.7 million contracts traded per day. Below we take a look at CME’s November performance across key asset classes.

Interest Rate Derivatives Drive November Volumes for ICE
After witnessing a slowdown in October, trade activity rebounded in November for Intercontinental Exchange Group with average daily volumes of futures and options traded on ICE rising by 13% year on year to 5 million contracts per day. The improvement was primarily attributable to growth in trade volumes of interest rate contracts and agricultural derivatives. Moreover, ICE launched its trading and clearing platforms for its Asian platforms – ICE Futures Singapore and ICE Clear Singapore – in mid-November. Below we take a look at some of ICE’s reported trading metrics for November and our full year forecasts for them.

Regulation & Enforcement

EU Derivatives Clearing Fight With U.S. Moves Toward Resolution
John Glover – Bloomberg
European Union regulators are considering amending rules on central clearing of derivatives trades in a bid to end a long-running dispute with the U.S. that threatens to fragment markets.

U.S. fund sector fears SEC proposal on derivatives may hurt ETFs
Trevor Hunnicutt – Reuters
A U.S. Securities and Exchange Commission proposal to clamp down on how funds use derivatives has industry officials worried that some exchange-traded funds may have to close or change their investment strategy.
The rule proposed on Friday would require funds to hold cash reserves to cover potential future losses on derivatives.

SEC Considers New Rule to Restrict Use of Derivatives by Investment Companies
Katten Muchin Rosenman LLP – Lexology
The Securities and Exchange Commission proposed a new rule aimed at limiting the leverage registered investment companies could obtain through the use of derivatives transactions.
In addition, the SEC’s proposed new rule would require investment companies to set aside in segregation qualifying assets to meet their mark-to-market liability as well as to cover potential future losses on derivatives transactions. Also, investment companies would be required to establish a formalized risk management program to manage the risks of derivatives transactions if they engaged in more than a limited number of transactions.


SPY Levels to Watch as Fed Catalyst Looms
Todd Salamone – Schaeffer’s Investment Research
It was plunging oil prices and weak world markets that spurred a sell-off last week, with the S&P 500 Index (SPX – 2,012.37) lower by 3.8% — but small-cap equities, as measured by the iShares Russell 2000 ETF (IWM – 111.91), led the way with a 5% loss on the week. The IWM fell beneath its January 2015 lows in the 114 area, and now the September trough in the 107 area becomes a strong possibility.

It’s time to buy insurance: David Rosenberg
Amanda Diaz – CNBC
The highly anticipated week of the Federal Reserve’s policy decision is finally upon the market. As Wall Street braces for what could be the first interest rate hike in nearly a decade, one top economist warns it’s time to buy insurance against whipsaw price action.


How to Value a Share Option — Part I
Matt Hibbard – MoneyMorning
When you buy shares in a company, there are a number of factors you might consider. For example, you might look at its fundamentals — things like the balance sheet, gearing, profit and loss, earnings per share and dividend yield.
You might then take a broader look at the industry it operates in and the health of the economy in general. If you like to use price charts, you might also check to see if the stock price looks to be in an uptrend.

How to Value an Option — Part II
Matt Hibbard – MoneyMorning
Last week we looked at how to value an option. If you recall, there are two basic components that combine to give you the value of an option — intrinsic value and time value.
Intrinsic value represents how much an option is in-the-money if you exercise it right now. For example, if a share is trading at $5.50, then a call option with a $5 strike price has 50 cents of intrinsic value. Or, if a share is trading at $10, then a put option with a $12 strike price has $2 of intrinsic value.

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