SPY / 4 vs UDN

Here we are looking at the ETF that tracks the S&P 500, SPY, divided by four to make it comparable to UDN. UDN is the ETF that is inverse to the dollar index. From the creation of UDN, its correlation with SPY is 24% which is significant.

The next chart looks at the same two ETFs over the last year.

SPY / 4 and UDN 6/2008-8/2009

The correlation has increased to 31% for the period shown from 6/2/2008 to yesterday. The interesting thing is that in the 163 trading days in 2009, during 114 of them, UDN and SPY were in the same direction, while 46 of them they went in opposite directions. (Three of them, UDN had no change.)

So it would be interesting to see if we can predict the direction of the market by looking at the overnight movement of the dollar.

Stay tuned!

If one instead bought Liberty and shorted DTV, then it wouldn’t have mattered how the discount narrowed. The simplest way to do that is to use a one factor model, and the wrong factor at that, the market as a whole.

The beta for LMDIA is 0.9 and the beta for DTV is 1.1. Beta measures how much a stock rises given a rise in the market, so LMDIA is a little more sluggish than the market and DTV is a little friskier.

LMDIA was $25 last August and DTV was around $28 so if you bought 1,000 shares of LMDIA and sold 900 of DTV to take into account the difference in beta and make the trade for no, or small, outlay of cash,
how would the trade have done?

DTV closed yesterday at 23.66 and LMDIA at $25.42. So the return on LMDIA was $420 and on DTV $3906. The bulk of the return would be on DTV if it could be borrowed.

Some of the stocks increased their market caps to be in contention and their per share price went over $1 which is necessary to get into the index. WAVX went from $0.89 to $1.12 HEB went from $0.53 to $1.69 and a market cap of $43 million to $143 million on trading all of the month of May.

The other trades I thought about doing where all bullish. They are related to a previous post “The Barron’s Effect”. There were several stocks mentioned very positively this week in Barron’s. How did they do compared to the four and one half percent fall in the overall market?

Baxter International is a medical equipment and supply company. It was up one half percent today.

Waste Management Inc is the biggest trash hauler in the country. One of the feature stories put it on the Green Dream Team of companies since it does so much recycling of the trash it picks up. The market was not convinced, WMI was down 4.4% with the rest of the market.

FPL Group, Florida Power and Light, is an electric utility and has a non regulated subsidiary that produced energy from wind and sunlight.  It is another Green Team Member.  FPL was down two percent today.

Jacobs Engineering,  a third team member, was down ten percent today.

So much for the Barron’s effect of that article

I’m glad that I tested it rather than traded those ideas.

So Barron’s hired Audit Integrity to evaluate which companies might have to take a charge  this year. They have a methodology for calculating the probability of negative earnings surprises. It is a forensic accounting exercise, they look to see if there are signs of trouble on the company’s balance sheet.  In this case, they are looking at companies that use aggressive accounting.

In the article they mentioned several companies that recently took a goodwill impairment charge.  Let’s look to see if that was already discounted by the market or lead to a surprise and thus a large move in the stock.  That is what we need to use this information in our trading.

NYSE Euronext, NYX, would have had a profit if not for the charge that it took last week.  They announced earnings on February 9th.  If you look at the daily chart, there is no sign of a large price bar on the 9th or 10th. The price is fluctuating within the trading range of the week before.

The stocks which Leslie Norton discusses in the article which moved on earnings announcements where all financial stocks, Fifth Third Bancorp, Regions Financials,  and Hartford Financial.  It seems to me, without investigating any further, I did look at Regions Financial’s stock chart, that the movement has to do with the volatility of financial stocks not the goodwill impairment.

Transocean (RIG) is on the list too and I bought a straddle last week looking for an increase in volatility and a possible spike when earnings are announced tomorrow.  Right now, the call is in the money, we will see if there is a move due to earnings this week.

Sell Puts Instead of Buying Stock

AA starts off the Q4 earnings season. It warned earlier that it was cutting 13% of its workforce and shuttering capacity. Then, after the close Monday, AA announce just how badly they did. Analysts were expecting a loss of 0.10, and AA came in with a loss or $1.59 for the quarter, killing most of its profit for the year. The bad news is out, so today, Today, Tuesday 13 January 2009, I sold 6 Feb 10.

I sold the puts slightly in the money. The historic volatility is 83.3% while the puts have an implied volatility of 83.4% That isn’t what I want. I want the implied to be higher than the historic. One can argue that the historic includes the huge fall in price in Oct and Nov 2008 and is unlikely to be repeated in the next 39 days. But that isn’t how I want to trade.

The put expires in 39 days and then I can repeat. I earned $765.54 in premium. My margin requirement is $2265. Of course, if it is put to me in February, I need to have 600 * 10 / 3 = 2000 to buy it on margin.

Trading Volatility

The way the ancients would do this trade is to sell the put and then sell half the stock. Since the probability to have the stock put to me is ½ , if I am short 300 shares of stock, I am covered. That way, I make the difference between the implied volotaility and the actual volatility over those 39 days.