Back to normal volatility

Curiously, the VIX, after spiking in the aftermath of the Japanese earthquake, and the onset of the military action in Libya, went to a peak of about 30, has slid back down to about 20:

Most people make the mistake of thinking that the VIX is predictive – it is not. It does anti-correlate with the S&P 500, however.

The real question that investors should be asking themselves is that was this just a single ripple in the market pond, or is this a good time to be loading up on index put options while the volatility is still cheap?

Notably, the April VIX futures closed at 21.50 today; going further out, July closed at 23.10. These products are not easy to trade profitably unless if you have a sharp computer model working in your favour.

Group Contrarianism and Japan

My very quick judgment is that “buy Japan” has been contrarian mantra issued to so many people that it now is conventional wisdom.

There is always opportunity to invest in companies that are in the middle of massive public scandals (e.g. BP), but whether such opportunities become a good value is whether people massively misjudge expectations.

In the case of BP, it was a political execution that translated into a disproportionate hit on the share price. In the case of “Japan”, it is very difficult to make the same judgment.

Hence, I’m keeping my eyeballs elsewhere.

Canadian Interest Rate Futures

Examining the short-term interest rate expectations of the futures market:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 AL 0.000 0.000 98.710 0.000 0
+ 11 MA 0.000 0.000 98.640 0.000 0
+ 11 JN 98.660 98.665 98.670 -0.005 17877
+ 11 SE 98.490 98.500 98.500 0.000 25173
+ 11 DE 98.310 98.320 98.310 0.000 32785
+ 12 MR 98.130 98.140 98.140 0.000 15601
+ 12 JN 97.950 97.970 97.960 -0.010 4616
+ 12 SE 97.770 97.790 97.790 0.000 945
+ 12 DE 0.000 97.640 97.610 -0.030 648

The Japanese earthquake and general instability in the marketplace has driven the June futures up from 98.545 on March 1st to 98.66 today – which is pricing in a small chance that the Bank of Canada will increase interest rates on their May 31 interest rate announcement. It is far more likely that the short term rate will be 1%.

The futures still anticipate that the year-end short-term rate will be 1.5%, so it will be interesting to see if this comes to fruition. With reports of food inflation rising (primarily due to commodity price increases), the Bank may have to make an undesirable decision to raise interest rates to stem inflation, which would have an adverse effect on the economy and stock markets.

I stated earlier I do not expect the Bank of Canada to raise interest rates until 10-year government bonds go above 3.5%, and they are presently at 3.19%:

Notably, the Canadian 10-year bond is trading at a yield of 10bps less than the US 10-year note.

A misconception in retail investing

When I have tolerance for it, I browse the Canadian Money Forum. There are a staple of regulars there, some that know what they are talking about, and some that sound like they know what they are talking about, but don’t. Then there are the batch of people that don’t know what they are talking about. It is a surprisingly good indicator of retail sentiment, especially in the younger age category (who presumably don’t have access to millions of dollars of capital and can’t move markets, but would generally be indicative of the mentality of higher risk-taking individuals).

A large misconception I see concerns dividends. I will state the misconception:

Misconception: Dividends add value.

They do not. Dividends represent a direct transfer of cash from the company to the shareholder.

Sometimes dividends subtract value, when the consequences of taxation are considered. In Canada, the eligible dividend tax credit mostly eliminates the penalty of double-taxation for non-registered accounts. In the USA, qualified dividends receive preferential tax treatment, at least until December 31, 2012 with existing legislation.

A mistake that retail investors make is that a higher dividend yield means the company should be more valuable.

The stereotypical trader – the deal with multiple screens

I noticed with amusement (courtesy of MaoXian‘s links) of some commodity trading company advertising the fact that they have cots in their offices, just in case if the market has a meltdown while sleeping – presumably they will be there to liquidate their risk.

Just in case if the link becomes broken, I will post the images:

I note with curiousity that this person’s desk has five screens, plus one screen on a notebook, plus huge billboards with coloured text display. There is enough room on the wall for a static painting depicting a trading pit. Other images of desks of “stereotypical traders”, especially those working at home, seem to concentrate on having as many flat panel displays as possible, presumably to alleviate themselves from having to get enough sunshine for the day because they can glow with the light from their screens.

I don’t know how such a setup actually improves decision-making ability. Throughout my life, I have made most of my investing decisions sitting in front of my “trusty laptop”, which has evolved from a 15.4″ screen to a 17″ screen. Most of the trades I create are done in the late evening, and I most often get up later than the 6:30am Pacific Time market opening to see what happened. My style is significantly different than trader-types: I don’t really care about the intraday charts of stocks other than just as a curiousity. I also do not sleep with my computer.

Obviously it would be stupid to be a chart-trader working off of a 10″ netbook, but there has to be a point of diminishing return before there is just simply too much screen real estate in front of you and your actual decision-making ability becomes blurred with all the junk that is presented in front of you.

There is a quote on the commodity trader’s website:

Last Friday when corn made a limit move before the sun had come up and most brokers had brewed their first pot of coffee, an entire world of million-dollar opportunities came and went. For this very reason, we’re seeing a dynamic shift in the names and faces that are most successfully monetizing these markets. And it’s tremendously gratifying to see hard workers rewarded for their efforts across a more level than ever playing field.

Making the most money you possibly can from these markets, indeed, requires a whole new level of dedication. And given the great many friends and acquaintances I’ve made after-hours on Twitter, I realize that a lot of traders are quickly discovering this reality. And they’re cashing in on it every day. Along the way, they’re lending credence to the famous quote from Elbert Hubbard: “Folks who never do any more than they get paid for, never get paid for any more than they do.”

This might be true, but do you really want your portfolio manager to wake up to an alarm generated by the computer and then having to make a snap trading decision while you’re still shaking off the cobwebs from REM sleep? For some it might work, but for me, I prefer less dramatic techniques to extract money out of the marketplace.