“If it flies, floats or %@#!*s, it’s going to cost you money.” These were the words uttered to me by my trading desk boss many years ago. He would later go on to learn the true expense of two of those “F’s” (he didn’t know how to fly) when his ex-wife was awarded Canada’s largest monthly child support remuneration ever issued by a judge. I know that sounds crazy and I didn’t believe it either until I looked it up. I think that most couples of that income level find ways to avoid the public disclosure of a court fight, but my old boss was not one to back down from a fight. So instead of quietly settling out of court, he went the whole way, and lost. Big time. And so he has the dubious honour of having the largest monthly child support payments ever awarded by a Canadian court.
I am not sure if my old boss changed the saying to reflect his experience, or if it is a sign of our ever increasingly dependence on credit, but today the much more popular version of this saying is; “If it flies, floats or %@#!*s, it’s better to lease it than to buy it.”
But I bet that famed hedge fund manager Ken Griffin didn’t lease the 72 foot Princess Yacht that he was spotted on this week-end.
72 foot Princess Yacht</a> </div>
Now a billionaire hedge fund manager aboard a multi million dollar yacht is about as unique a sighting as Lindsay Lohan inside the Pink nightclub on her 17th red bull and vodka. But the name of Ken’s yacht is what is most interesting.
Ken’s yacht</a> </div>
The name of the boat is “Moar Theta” which is a joke that only traders familiar with option pricing theory are going to understand. Theta refers to the measure of the rate of decline in the value of an option over time. Some traders like to think about it as the decay rate of the option.
If you are long options, then you are said to be long theta (although most people use the expression long gamma which goes hand in hand with long theta). Every day that you are long, the option decays a little. As a trader you hope that a move in the underlying asset will be larger than the decay (or that the market reprices the implied volatility and that your vega kicks in), but you are battling the ever present ticking decline in the value of the option.
If as a trader you are short theta (or short gamma) then you experience just the opposite scenario. Every day the options you are short decay in your favour. You are hoping that the moves in the underlying asset are less than the decay.
Most novice traders usually buy options and for a long time, most professionals used to sell options. Then 2007/8 happened. During this period the underlying moves in the assets were so large that no one could afford to take the chance of shorting options. Everyone wanted to buy protection and no one wanted to sell it.
This is why the VIX and other measures of implied volatility soared to such absurd levels.
Since the credit crisis we have had other mini-scares, but on the whole, volatility has been on a constant decline. During this period, investors have been consistently over paying for protection. The 2007/8 crash is still too fresh in their minds.
Although recently I have bought some SPX puts as a hedge, for the longest time I have been recommending to avoid buying VIX volatility. This was due to the fact that investors were overpaying in the anticipation a 2007/8 type crash.
I was not smart (or bold) enough to sell volatility (short theta) during this period that investors were consistently overpaying for protection. But it really was the trade of the decade.
Have a look at the iPath S&P 500 VIX volatility chart. This ETF was designed to track the VIX. It was created at the height of the crisis and has been on a consistent plunge lower ever since:
iPath S&P 500 VIX ETF</a> </div>
I had to make the scale logarithmic because the constant halving of the ETF caused the decline to make it look too much like a waterfall. But I wanted to show how on a percentage basis, the product keeps declining. Have a look at the scale on the right. This product has gone from $10,000 to $33.
And guess who was on the other side of this trade?
You got it! Moar Theta!
Although I have no way of knowing if Griffin’s Citadel was specifically short VIX or not, the name of boat suggests that Ken has taken advantage of the general decline in volatility (and investors’ constant over paying for it).
I have always wondered who was selling volatility. It used to be a favourite trade of investment dealers’ proprietary books. In my years on the index derivative desk we were practically always short theta. It made sense for us to assume that risk as we were already trading every day and we were most efficient at delta hedging. But the huge losses that dealers took in 2007/8 and the introduction of the Volcker rule has to have cut down on that strategy for dealers.
This has probably made it all the more profitable for hedge funds like Citadel to be providing that liquidity.
But as George Harrison taught us – All things must pass. And just as night follows day, this trade will end.
Volatility has shrunk to minuscule levels. And although investors are still slightly over paying for protection, they are gradually paying less and less. The premium that firms like Citadel can charge has been steadily eroding.
I have been waiting for a sign that volatility is a screaming buy. I have been patiently avoiding getting long VIX as I thought too many people were trying to buy it.
This late spring push down to new lows peaked my interest.
VIX index</a> </div>
And then recently, I have noticed an increasingly frustrated group of traders that have given up trying to bet on a serious correction. Although many market participants seem to hate the market, they have completely abandoned trying to profit from a correction. This is part of the reason the VIX is collapsing. The fear has left the building.
And as far as Ken’s yacht goes, I remember this great news report that I watched many years ago about boat builders. The report chronicled how boats were the ultimate luxury that seem to be the last thing that was bought before the end of the good times. The news reporter interviewed a NYC boat dealer that listed all the different cycles and how he knew the top was coming when he started selling a lot of boats.
I have been waiting for a sign that it was time to get long volatility. Ken Griffin’s boat “Moar Theta” is my sign.
My old boss warned me about how expensive boats can be, but I don’t think he ever considered the risks of also angering the Market Gods by naming your yacht after a particularly good trade. This lack of hubris is the exact kind of thing that happens near the end. Let’s hope Ken at least has the good sense to leave the other two “F’s” alone.
Buying more GDX
When I entered into my long GDX trade, I highlighted that I was prepared for it to go against me, and that if it dipped below $23, I would buy more.
At the risk of breaking the cardinal rule of trading by adding to a loser, I started to buy more GDX yesterday.
GDX – Gold Miner ETF</a> </div>
I am sticking to my plan. I don’t think there is any rush as the chart looks terrible. Over the next couple of days I will continue to add to the trade.
The precious metals continue to stink up the joint, but I have a new theory that I will write about tomorrow that explains the recent weakness.
In the mean time, I want to highlight that last week GLD shares were actually created instead of being redeemed.
GLD price vs GLD shares outstanding (yellow line)</a> </div>
I know right now everything feels terrible for all things precious metals related. I am not yet ready to catch this falling knife by adding to my actual long metal position as this was the first day of the break down. But I will be adding, it is only a question of when. Real rates are going lower, not higher. The fundamental reasons for owning precious metals are getting stronger, not weaker. If the Fed was cranking rates in a Volcker style curve inverting campaign I could see abandoning my long precious metals trade. But in fact, just the opposite is happening. The precious metal downside price momentum is accelerating, but I refuse to hate it more as it goes lower. More to come tomorrow…
McCulley is returning
Yesterday it was announced that PIMCO legend Paul McCulley was returning to his old firm in the role of head economist. I have always felt that Paul was the best of that group and I am thrilled that he is going to be returning.
However I am concerned that he might have killed off a few brain cells while he was on hiatus though.
Have a look at a before and after picture:
Paul McCulley</a> </div></p>
Most commentators are comparing McCulley to the dude from The Big Lewboski:
The Dudes abide</a> </div></p>
But I personally think it is no coincidence that the Bluth family from Arrested Development live in Newport Beach and that PIMCO’s headquarters are there as well. My suspicion is that Paul has been helping out Oscar with his “afternoon delight.”
Afternoon Delight – aka Turtle killer weed</a> </div>
In all seriousness though, Paul is generally credited to bringing the term “Minsky moment” to the forefront of recent economic thinking.
Won’t it be ironic if his return marks the tipping point of this crazy credit creation ponzi scheme? If that does come to be – don’t forget there is always money in the banana stand…