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Voice of Reasons


One of the notable elements of the "FOMC hope" rally during the front end of this week was that volatility never appreciably "came in."


"Hey baby, there ain't no easy way out" Tom Petty.

We interrupt this morning's usual format to bring you several thoughts on the world at large and the circumstances that surround us. Please excuse the staccato style as there are some days that allow for foxy favor and other that require nuts and guts. We'll be back in a bit with the regularly scheduled Freaky Friday Potpourri but let's dive in and truck through the muck.

  • We've been speaking of bubbles in the 'Ville for a mighty long time, from to real estate to sentiment to debt to derivatives to hedge funds. We got some strange looks while the screens were green but that's the price you pay when you're on a stage. Listen, we don't want the sky to fall and we're not rooting for Boo. We know that nobody wins in a true bear market-not even the bears-but we share our fare with hopes that it adds value to ye faithful. Minyanville has a truly benevolent mission-financial infotainment and education-so please keep that in mind as we skate through the unwind.

  • One of the notable elements of the "FOMC hope" rally during the front end of this week was that volatility never appreciably "came in." Despite the sharp snapper and the collective "all-clear" by the media, the VXO hovered near 20. That's important in the context of negative gamma that became standard fare during the multi-year liquidity driven low volatility environment. There are a slew of "income funds," hedge funds and dealer desks that are "short vol" (around VXO 10-12) and trapped. That, as much as anything else, is the reason behind this whippy rhyme.

  • Looked at another way, there were a TON of cheap options in the market place in 1987 (which, by definition, have higher gamma) and accounts sold slews of puts at "teenies" and "eighths." The last few years, "income funds" sold cheap calls against their stock holdings (called "buy-writes). The irony? The risk profile of "long stock-short call" is the same exact thing as a synthetic short naked put. If you wanna understand more about this dynamic, please reads Professor John Succo's tutorial on derivatives. He remains the best risk manager I've ever had the good fortune of knowing.

  • We spoke on Wednesday about the "Fed in a Box" and that remains in play as we wiggle and fray. While Fed Fund Futures are implying a "100% chance" that the Fed issues a (cough) surprise rate cut, the implications would be far reaching in a few regards.

    • The Dollar-Yen is trading in lock-step with equities as the carry trade unwinds (it's been the source of liquidity). If (when) the Fed cuts, the Yen will likely lift hard (negative implications for stocks).

    • China, which we highlighted in our column as the invisible gun to our Central Bank's head, threatened a "nuclear option" with regards to dollar sales the same day that column posted. If you haven't noticed, China is trading at an all-time high. Sorta like Japan did in the late '80's, when the last "transfer of wealth" took place. Déjà vu, eh?

    • Three short days ago, the FOMC put on a brave face and offered that the risk to the economy was skewed to inflation. If they turnaround and cut, their Street credibility will be called into question. And as psychology is bridge between perception and reality, that shift in sentiment would be a viable risk.

    • If (when) the Fed cuts, you won't be able to buy the gap higher. That is one of the reasons that I'm making disciplined sales on my puts on the way down. Still, I believe that once that dust settles, the market will resume its move to the downside. Case in point was the first rate cut in January 2001. We all know what happened from there.

  • Countrywide Financial , the biggest U.S mortgage lender, said it faces "unprecedented disruptions" in their operations, another proof point that the credit crunch that started in sub-prime isn't as contained as Hank Paulson, Ben Bernanke and other Fed officials assured us it was. The lesson? Understand the agendas in play and the high stakes involved. YOU, at the end of the day, are the sole arbiter of your financial fate.

  • As Minyans know, I faded (read: shorted) the leggy lift into S&P 1488-1965 with a stop above BKX 111.50. BKX 101.50 is the recent low for the banks and a level of lore for the bovine in our midst (who wanna see a "higher low" if possible or a "double bottom" worst case). Bigger picture, S&P 1370 is an intuitive level of support (the trendline from 2002) and IF (big if) we get there on a whoosh, I'll tempt fate, flip lids and give Hoofy the benefit of the short-term doubt. So you know, I'll be paring some puts into the opening (takes my position down to about 25% of the original size) and will look to "roll down and out" (lower strike) should we see a sharp lift back to resistance.

  • You wanna hear something crazy? The S&P, as of yesterday's close, was 20 handles higher for the week. Still, officials around the world- from the ECB to the U.K to Germany to Canada-were attempting to assuage fears. On top of that, the DJIA, S&P and NASDAQ remain up mid-single digits for the year! If this is fear, I would hate to see what happens if and when we flip the performance switch. Professor Woody Dorsey, who is the thought leader in behaviorial science, has recently written on this.

  • Overnight, Japan injected $8.5 billion, Australia injected $4.2 billion, the ECB injected another $61 billion (on top of yesterday $130 billion) and the U.S Fed tossed another $19 billion into the system (on top of yesterday's $24 billion). Again, with the global equity markets UP on the year, the question is again begged: What is the looming shoe that they see?

  • If someone put a water-pistol to my head and asked me what my near-term "most likely scenario was, I would offer that this is the Friday that doesn't get bought, sparking comparisons to Black Friday and Crash Monday. I then foresee the FOMC rate cut Monday morning, which would thread back into the discussion above. This is a nonsensical back-of-the-envelope thought, mind you, but it's been rumbling around my head all week. While I sorta saw a rally into the FOMC and a harsh gut check after, I didn't get this granular. I offer this with a conscious nod to the trading Gods and with the disclaimer that your guess is as good as mine.

So very much going on and I've gotta hop over to the Buzz & Banter. Take a deep breadth, review our Ten Trading Commandments and remember that the definition of an investment should never be a trade gone awry.

Good luck Minyans.


No positions in stocks mentioned.

Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at

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