Slope Of Hope with Tim Knight

Land of the Free. Home of the Brave.

I woke up this morning to an interesting juxtaposition.

First, in the nearby bucolic town of Davis, California, some students were participating in an Occupy event. The police - - who, in my experience tend to be little people who like to feel like Big Men with their billy clubs and pistols and stupid dark gunglasses and black boots - - decided to show these people who were expressing their opinions exactly who was in charge and doused thoroughly them with pepper spray.

In case you think this photo is 'shopped in some way, here's the video. This took place just yesterday, I believe.... 

And, as freedom-loving Americans were being saturated with chemicals, there's this story from China in which financiers (the same ilk as, say, Richard Fuld, Lloyd Blankfein, and all the rest) were sentenced to freakin' death for defrauding citizens.

And the amount - a billion bucks - is miniscule compared to what we've seen over here. And, yeah, yeah, I know - - Madoff - - but he made the mistake of ripping off, shall we say, the wrong people.

It's just eye-opening to read on the same morning about how the police state is blossoming here in the U.S. against innocent regular people, and yet when it comes to meting out justice to the real criminals, that job has to be left to China.

And where does that leave us? A terrified population of little people and a handful of dick-swinging bullies at the top who know that, as long as they don't set up shop in China, will be richly rewarded for their crimes.

This is the New America.

Just Keep Digging (by Springheel Jack)

No man's life, liberty, or property is safe while the legislature is in session. - Mark Twain (1866)

You see a lot of stupid comments made about the financial crisis and what should be done about it, and one of the most dangerous was made over the weekend by Vince Cable, the UK Business Secretary, when he proposed that the ECB should be given unlimited powers to support the Euro and the region's debt-ridden economies. You can see the full article at Bloomberg here.

POTW: Civil Servants

This post's pissing and moaning is on the topic of civil servants.

By that I don't mean each and every civil servant individually. Some government workers are just fine and dandy. I've got no beef with the fellow who brings me my mail, or the utility worker who inspects my electrical panel, or the police officer directing traffic at the broken stoplight. They're all doing their job, and those jobs are needed.

Another Rousing Government Success Story

Comfortably Numb

Is the Pope a Catholic?

Yeah, yeah, the downgrade, I know. An article on biofuels doesn't speak to its urgency. But I was on a plane. To explain:

I'm a bit of a nervous flier. I guess, being somewhat of a control freak (ahem.......), it's unsettling to be in any situation in which I have absolutely no control over what's going on. After all, if an airplane gets into trouble, the most I can do is chat with God and work out the terms of the life of charity I shall lead in exchange for not plummeting to earth in a metal cylinder.

So as I was flying from Chicago to Denver yesterday evening, there was a large thunderstorm positioned directly - and I mean directly - over the Colorado Springs airport. The woman next to me, whom I guess had been through this kind of thing before, said, "we're going to be up here a while." And she was right.

We made a huge circle around the storm for half an hour, spending about half the time violently shaking as the air buffetted us. It was the worst plane right I had ever been on, and all I could think about was how nice it would be to get us safely landed on the ground. The shaking and the flying seemed interminable, and I kept worrying who would NEW POST this site for the rest of eternity if I were to perish at such a youthful and surprisingly handsome age.

Well, I obviously made it, and my pact with God was amorphous enough that my spending time sharing my thoughts on the market for no charge strikes me as adequately charitible that I think God will approve. So I resume to the struggle.

So the big news is that S&P has declared that, in a nutshell:

+ The United States and its future does not present the most unquestionable credit risk

Not to do S&P's job, but I'd like to supplement their findings with some other equally salient facts:

+ Ophra Winfrey is, and always will be, on the fat side;

+ Julia Roberts and Anne Hathaway have unnecessarily gigantic teeth;

+ Barack Obama enjoys making public speeches

So how will the market react? I'm not sure. I've become so accustomed to perverse market reactions that I would not be surprised at all - in fact, I would be kind of pleased - if the market wound up closing higher on Monday.

As a bearish sort (perhaps I should have added Tim is a Bear to the bullet points above), I am obviously pleased with the market action we've seen lately. But - as a perpetually dissastisfed sort as well - I keep having two contrary, bummer-like thoughts:

+ I sure wish I had even more shorts on;

+ I wonder how long it'll be before we get the big bounce I need to go 200% short

I mean, I've been almost purely net short for a while, and last week was beneficial for me, but many stocks that I wanted to short at better prices still got clobbered by 15%, and I was not there to partake.

I tend to have a "bottoms-up" approach to my analysis, and the preponderence of evidence tells me that the shorting opportunity of the decade is coming up, but it requires a substantial bounce to make the risk/reward worthwhile. By "substantial", I don't mean new recovery highs - - but a 4% to 6% push higher on the big indexes would do the trick (which, for some stocks, would mean a 20%+ rise).

As for the Fibonacci time series, I remain blown away that the video I did on May 2nd (which, conicidentally, was the recovery high) specifically mentioned August 5th as the bottom for the cycle. What's the next bottom? It looks like February 3, 2013 - - which would make a certain amount of sense, since whoever President we wind up with in November 2012 will probably start off with a market that's in a death-spin.

In any event, I remain totally short, but only lightly committed, and Monday bears very close watching. Have a good Saturday.

Hedging Against a Dollar Drop

Chafing at the world's reserve currency

After the excitement of the U.S. debt ceiling negotiations going down to the wire, Russian Prime Minister Vladimir Putin offered these comments about the U.S. and its dollar:

They are living like parasites off the global economy and their monopoly of the dollar.

[...]

If over there (in America) there is a systemic malfunction, this will affect everyone," Putin told the young Russians. "Countries like Russia and China hold a significant part of their reserves in American securities ... There should be other reserve currencies.

With Putin's sentiments in mind, let's look at a way to hedge against a further drop in the dollar

Hedging the dollar

The steps below show how to hedge the dollar by buying optimal puts on the PowerShares DB USD Index (UUP) as a proxy for it. First a quick reminder about what optimal puts mean in this context.

About optimal puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task. With Portfolio Armor (available on the web and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own, and the maximum decline you're willing to risk (your threshold). Then the app uses an algorithm developed by a finance Ph.D to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

A step by step example

Step 1: Enter a ticker symbol

In this case, we're using UUP as a proxy for the dollar we've entered UUP in the Ticker Symbol field below.

Step 2: Enter a number of shares

For the purposes of this example, let's assume an investor has a $1 million portfolio, all in dollar-denominated assets.  So, since we're using UUP as a proxy, the number of shares we'll enter will be $1,000,000 / the most recent share price of UUP ($21.17, as of after hours Monday) = 47,236.7. We've rounded that up to 47,237 and entered that number in the "Shares Owned" field in the screen cap below.




Step 3: Enter a decline threshold

You can enter any percentage you like for a threshold when using Portfolio Armor (the higher the percentage though, the greater the chance you will find optimal puts for your position). I've entered 15% in the "Threshold" field below.



Step 4: Click the red button

A moment after clicking the red button, you'd see the screen cap below, which shows the optimal put option contracts to buy to hedge against a >15% drop in UUP between now and March 16, 2012. The cost of this protection on a $1 million position would be $6,608, or about 0.66% of the position value.<sup>1, 2



1</sup>Note that, in this case, Portfolio Armor rounded down the number of shares of UUP we entered to the nearest hundred (since one put option contract represents the right to sell one hundred shares of the underlying security), and then presented us with 472 of the put option contracts that would slightly over-hedge the 47,200 shares of UUP they cover, so that the total value of our 47,237 shares of UUP would be protected against a greater-than-15% decline.

²To be conservative, Portfolio Armor quoted that cost based on the ask price of the optimal puts. In practice, an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask.

Three-Dimensional Market Analysis Videos

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U.S. Citizens and Their Government (NSFW)

Costs of Hedging Treasury Bond Exposure Still Low, but Rising

The chances of a debt ceiling deal

The Intrade prediction market enables participants to bet on whether Congress will approve an increase in the U.S. debt ceiling to $15.1 trillion on or before three dates: July 31st, August 31st, and September 30th. As of Tuesday evening, these were the chances of debt ceiling deals by those respective dates:

• July 31st: 16.2% chance of a deal raising the debt ceiling to $15.1 trillion
• August 31st: 75% chance of raising the debt ceiling by that much
• September 30th: an 88.9% chance of raising the debt ceiling by that much

Unfortunately, Intrade doesn't offer a market for betting on whether a debt ceiling deal will be reached by August 2nd, the putative deadline.

Breaching the debt ceiling need not lead to an imminent default

If Congress can't come to a deal raising the debt ceiling in time, the U.S. government will not be able to borrow to pay all of its obligations, but that doesn't mean this will necessarily lead to an imminent default. The government could instead prioritize payments so that holders of Treasury securities get their interest payments as scheduled, while withholding payment from other parties (e.g., by furloughing some Federal workers, or by delaying some transfer payments).

Nevertheless, a failure of Congress to reach agreement on raising the debt ceiling would be inauspicious for holders of Treasury bonds. Another point to consider is that, even if a debt ceiling deal is reached, U.S. debt may still be downgraded at some point, which could lead to forced selling by funds which are required to own only AAA-rated bonds.

Hedging against a failure to raise the debt ceiling

In a post elsewhere earlier this month ("Helping House Majority Leader Hedge His Treasuries Exposure"), we noted reports that the House Majority Leader held "up to $15,000 in shares of the 2x levered ProShares Trust Ultrashort 20+ Year Treasury ETF (TBT)", an amount, we suggested, was probably too low to provide much of a hedge for his exposure to Treasuries.

A more precise way to hedge

As we mentioned in a previous post, precision is one of the advantages of using optimal puts, rather than inverse ETFs, to hedge:

• Precision. Say you own 824 shares of Exxon Mobil, and you'd like to know how to hedge that position against a greater-than-17% loss. Using Portfolio Armor (available as a web app and as an Apple iOS app), you could simply enter "XOM" in the symbol field, "824" in the number of shares field, and "17%" in the threshold field, and then Portfolio Armor would use its algorithm to scan for the optimal puts to give you that level of protection at the lowest cost.¹

The example above mentions a stock, but as we noted in that post earlier this month, Rep. Cantor could find optimal puts on the U.S. Treasury bond-tracking ETF, iShares Barclays 20+ Year Treasury Bond (TLT), as a proxy for his exposure to Treasury bonds, in the same way.

Hedging costs as of Friday's close

The table below shows the costs, as of last Friday's close, of hedging against greater-than-15% and -20% declines, respectively, in TLT until January 20th, 2012.

Symbol	Name	Decline Threshold	Cost as % of Position
TLT	iShares Barclays 20+ Year Treasury Bond	15%	1.22%*
TLT	iShares Barclays 20+ Year Treasury Bond	20%	0.66%*

Hedging costs as of Tuesday's close

The table below shows the costs, as of Tuesday's close, of hedging greater-than-15% and -20% declines, respectively, in TLT until January 20th, 2012. Note that the costs are still relatively low, but have increased since Friday.

Symbol	Name	Decline Threshold	Cost as % of Position
TLT	iShares Barclays 20+ Year Treasury Bond	15%	1.48%*
TLT	iShares Barclays 20+ Year Treasury Bond	20%	0.77%*

*Based on optimal puts expiring in January, 2012.

¹In that case, Portfolio Armor would round down the number of shares you entered to the nearest hundred (since one put option contract represents the right to sell one hundred shares of the underlying security), and then present you with eight of the put option contracts that would slightly over-hedge the 800 shares they cover, so that the total value of your 824 shares would be protected against a greater-than-17% loss.