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A Small Price to Pay


As most of you know, I have been a buyer of volatility, the implication being that money is to be made as various sectors of the market move around in a more volatile fashion than the options imply. My primary thesis is high private debt, primarily mortgage debt, relative to the total market capitalization of government bonds. This imbalance essentially creates a squeeze on companies as volatility rises in the bond market, stocks such as Fannie Mae (FNM:NYSE) and Washington Mutual (WM:NYSE). What is just as important as buying the right options is the methodology of trading the gamma.

I can either consider the market in a trading range or in some type of trend. If I believe it is in a trading range, I will trade my gamma aggressively: selling out any deltas quickly, re-hedging in the expectation that I can buy back these deltas at a lower price. If I believe the market is trending, I will trade my gamma less aggressively, carrying my long delta for a while in a rising market.

Today's stronger economic data might embolden the bulls, but in my opinion I believe that the market has already discounted much of this information. Economic numbers often create short term volatility that fades quickly, so my risk is that I do not trade it aggressively enough. Barring a Saddam rally, I still see a continuing distribution into rising stock prices, so my bet is that we are still in a trading range and I will be able to buy back my deltas lower. If I am wrong I may not capture the total future value of my gamma. A small price to pay.
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Positions in FNM and WM

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