Are Emerging Markets Moving into Bubble Territory?

There is one thing that is commong among all market bubbles: they are driven by money flows. When asset prices rise simply due to the huge amounts of liquidity, the market in question is susceptible to any changing market condition. It is important to remember that money can flow out faster than it might flow in. This is the situation developing with emerging markets today. Due to the inexistant returns on government securities and money market funds, as well as the sovereign risks in developed nations, investors have flocked to emerging markets as a source of diversification as well as extra return. However, this perception of diversifying risk seems to be a fallacy. Just looking at the returns of the S&P500 (green) and MXEF emerging markets equities index (yellow) shows the high correlation between emerging and US equities markets.

Despite EM equities offering a higher level of return, the returns have moved in lockstep with US equities. What is the danger of this? The danger is that market turmoil could easily spark a huge sell off in emerging market equities. Imagine a scenario where developed nations equities fall on sovereign debt fears. EM equities are still perceived as a very risky asset, and the sell off will be that much more volatile.

Another risk is the upcoming risk of rate rises in developed nation. This would bring back liquidity from return seeking investmetns back into the developed nations. The problem with liquidity driven asset prices is that small outflows may spark large outflows in a vicious cycle. Therefore a small catalyst can spark off a huge downward spiral.

Categories: Uncategorized

Head to Head: Goldman Sachs and Solomon Brothers

For those who do not know what Solomon Brothers is, go read Liars Poker.

5 months ago I emailed a good friend with the following message:

I am posting this as evidence of my prophecy if it does so happen that GS goes down.

In the meantime, other similarities:

  • Both leading securities/trading/prop disguised as market making firms
  • Both a very cult like culture that really defined the companies
  • Both got huge capital infusions from Warren Buffet as well as moral backing

This is a very broad look, and I will do more in depth research into the similarities over the upcoming week.

Categories: US

Warren Buffet hates derivatives…except when they are in his portfolio

It was interesting to see people excited to see Warren Buffet defend his stake in Solomon Brothers Goldman Sachs this past weekend, especially since it was the most obvious course of action. Of course Warren was going to stand behind the Gold boys, his 5 billion USD stake in preffered shares is plummeting. If he showed up at the shareholders meeting with any other statement other than support, it would be bye bye Lloyd. However, the really interesting point of the weekend was Warren Buffet speaking against the regulation of derivatives. Here is a man who once labeled them as weapons of mass destruction, who for some reason has enough derivatives in his portfolio that regulation could mean him having to post USD 8 billion of collaterall. The icing on the cake: Goldman Sachs is the primary derivatives counterparty with Warren Buffet. In this web of clusterpoop, Warren Buffet would actually demand an increase of premiums for his positions if he has to post collaterall (cuz Chuck Norris dont pay no collaterall costs), and so this is just another brick on top of Goldman woes.

The SEC and Goldman are in talks about changing practices and settlements, which would mean that GS will get some breathing room in todays trading (potentially), but they should not hold their breath, as I fully see the stoch heading downwards throughout the week. Therefore short Goldman with a long S&P 500 e mini contracts is the trade of the week. Goldman will not rally without a rally in the broader index, and so the sp500 is a nice hedge that leaves room for profitable scenarios.

Categories: US

[VIDEO] Quants: The Alchemists of Wall Street

Categories: Uncategorized

Are Japanese Bonds Defying Financial Gravity?

April 28, 2010 1 comment

I am pretty sure everyone has noticed that Greek 2 year bonds have had consecutive jumps of 3% in the past two days and are at a level of 18% while cash trading has pretty much dried up as bid ask spreads have widened. I dont know about you, but I would lend money to a chav at a rate lower than that. It seems like the clusterfuck Greece has found itself in is here to stay. If the EU/IMF bails them out, there will be such strict conditions to go along with it that they will be screwed for years to come. In addition, it will give the green light to the other farm yard animals (PIIGS) to let themselves go. If Greece defaults, you can say bye bye EUR as you are going down.

But saavy traders need to avoid overcrowded situations such as these, as there are loads of funds and traders can get trampled if there is a break the other way. Japan has the highest Debt to GDP ratio in the developed world (maybe the highest but I honestly dont even know how to audit the Zimbabwe balance sheet anymore), yet its 10Y yield has seen to be steady and has even dropped over the past month while Greece were arranging icing on their debt flavored cake.

JGB 10 Y Yields (Bloomberg):

Japan Debt/GDP Ratio (chart from seekingalpha):

What makes Japan invincible to the sovereign debt crisis looming? Three things:

  1. High saving ratio
  2. Current account surplus
  3. Perception of yen as a safe haven

Let’s face it, Greece did not have any of those things. However, the first two have been deteriorating over time. The government is trying to make sure the country gets out of a deflationary trap by spending and propping up its currency, and the current account surplus could be in danger. In addition the saving rate is slowly diminishing as part of the government led anti deflationary effort as well. However, the third bullet is the most important. As long as investors want to hold Yen denominated assets, the government can maintain this debt load. However, all this is is a matter of perception, as the Yen is regarded as a safe haven currency. Perceptions can change quickly, and if the market starts to turn on Japan, it will not belong before its bond yields are being greeted by Greece’s. If the market does turn against Japan, the Yen and JGB’s will get crushed as investors will flee out of its bonds and its currency.

Categories: Japan

S&T Summer Internship Guide

April 23, 2010 2 comments

The launch of the S&T Summer Internship guide is planned for the beginning of September, just in time for applications. The authors of the guide have final round interview experience at UBS, JP Morgan, Goldman Sachs, Barclays Capital, Deutsche Bank and Citigroup, as well as work experience at several of the aforementioned bulge brackets in sales and trading.

The guide will include:

  • Calendar of application dates, networking events at different universities
  • A complete list of sales and trading firms offering internships across the US and UK
  • A complete breakdown of the roles available in Sales and Trading
  • Tips on networking
  • Summer Intern Diaries and Day in the Life exerpts
  • How to write your CV and cover letter
  • Filling out online applications
  • How to prepare for interviews
  • How to succeed in first round interviews
  • How to succeed in final round interviews
  • How to prepare for your summer internship
  • How to convert your internship into an offer
  • Interviews with professional traders

We are offering readers of the opportunity to get on a shortlist for the release of this guide. By sending an email to expressing your interest, we will save your details, giving you the option to buy the guide when it comes out for a reduced price of 14.99 GBP. Think of this as a free call option with a strike of 14.99 :). The sale value when it comes out is planned to be 19.99, therefore by getting on the short list now, you can get a discount of 25%.

Categories: Uncategorized

Selling Volatility on Goldman

Warning: This strategy involves selling naked call options, and therefore a trader emplying this strategy has the potential to suffer unlimited losses.

The previous trade I wrote about regarding Goldman Sachs was a long vol play. Therefore hoping the implied vol rises between now and October as it was at extreme lows. This trade is a bit contrary to that, but offers a nice method of hedging the previous trade if its already on, and a good source of income if its not on. The strategy is basically taking advantage of the time premium longer dated options have. Looking at the GS options schedule:

Comparing the May and June 180 strike calls, the May is offered at 0.85 and the June is bid at 1.93. Now lets say you sell the June and buy the May. You come out with a credit of 1.08 per option. However, you lose money if GS is above 181.08 at the time of expiry on the third Saturday in June. This would equate to a return of 14.6% from current price levels. Looking back at the last ten years, the average return of GS 2 months after earnings is a measly 1.2%, with it breaching 14% only 5/36 times.

Looking at the fundamental forces, it seems that the financial stocks are dropping as hints of regulation are coming over wall street, commencing with Obamas speech this week. Even Bank of America Merrill Lynch has already sold off its private equity unit.

So let’s say a trader decides to employ this calendar strategy, buying 10 lots and selling 10 lots, with a credit of $10,800. Make no mistake, this is a very risky strategy, and the risk has to be managed. The trader has to know his stop point at which he will cover his June shorts. Imagine if GS is trading around 180 in June. Lets look at an ATM call for the May contract now, trading at around $6. If a trader has to cover at this level for 10,000 options, it would be a loss of 60,000-10,800 =$ 49,200. That is a very skewed risk profile, and that is what makes this strategy extremely delicate. However, there are alternatives, extending the options schedule you can buy May 200 calls for 0.13 and sell June 200 calls for 0.36, a credit of 0.23 per option. So if buying/selling 10 lots of each, that is a credit of $2,300. GS would have to have a return of 27% over the next two months to lose money on this trade. A return like this has happened once in the past ten years (in the middle of the massive 2009 rally).

Any trader should be aware of these types of premiums available, and a decision has to be made whether the downside risk is worth it.

Connecting this trade to the earlier trade I wrote about where we went long vol with Oct calls on Goldman Sachs. Employing these strategies increases the risk/reward ratio of this trade. If GS stock drops then volatility will increase and money will be made on the long vol position. If GS stock rises then volatility will increase causing the long vol position to offset losses on the naked call. The optimum position sizes depend on the risk averseness of the trader.

Categories: Uncategorized