Category: Finance

Probably due to Robinhood, retail investors are getting into the business of option selling. Almost nobody in the retail scope should be doing this. The new professed method to riches has been selling put spreads (likely due to the fact that margin requirements for spreads are lower than flat-out selling naked puts). Robinhood loves people engaging in these strategies since they make far more per trade. Put spread selling appears to have been, at least to the end of August, a viable manner of making untold amounts of gains as they are the recipient of both price appreciation and time decay (theta).

In fact, since early June, it would have been near-impossible to lose money employing such a strategy, which is why in the month of August, you probably had hordes of people self-educating each other on the virtues of selling put spreads for a limited risk method to making free money. Free money!

The issue with put selling is that when it works you make a little (especially in relation to what you could have made had you just bought the common stock directly), but when the trade goes against you, you lose a ton of money. Many retail investors fail to calculate their risk exposure, especially in market environments in the past few days where not only do you lose on price (the delta skyrockets) but also volatility (which inflates the price of a short position and makes it much more expensive to cover).

Now the tide has turned and people are finally seeing that such strategies can make a thousand dollars a week, but lose you ten grand in a day when you bet incorrectly.

Just reading the reddit group /r/thetagang, it’s pretty apparent that a lot of people viewed this as a low-capital perpetual money making machine, at least until now. The quantitative algorithms that take the other side of these option trades, for the most part, have basically won to a degree more than one would at a casino playing a reasonably fair game of blackjack.

Wow, that was quick.

I said less than two weeks ago:

One major event that will occur in the future (a matter of when, not if) will be a significant power grid failure that will have been instigated by having too much intermittent energy sources on the grid, without available backup from domestic or external grid sources. This may be caused by a freak transmission failure (cutting an intermittent-heavy grid from a dispatch-able heavy grid) or some other ‘black swan’ event. When this occurs, there will likely be a dramatic shift in power generation policy to increase the robustness of a domestic power grid.

And what did we get last Saturday? Headlines such as:

(August 14, 2020) * Stage 3 Emergency Declared; rotating power outages have been initiated to maintain grid stability
(August 15, 2020) ISO Requested Power Outages following Stage 3 Emergency Declaration; System Now Being Restored
(August 16, 2020) Flex Alert Issued for Next Four Days, Calling for Statewide Conservation

What happened?

Excuse my crappy handwriting, but I had to illustrate this. Factors:

1. Wind dies down (can’t predict the wind very well, so you have no idea what your future supply is going to be);
2. Solar gets interrupted during the peak of the afternoon due to clouds;
3. Natural gas supply is down due to plant shutdown;
4. Cannot import (other grids are facing similar demand/supply issues).
5. Record-high daytime temperatures (e.g. Riverside, CA which is a suburb about 80km east of Los Angeles, at daytime highs of 40 degrees C), which causes huge demand for air conditioning.

What do you get? Rotating blackouts.

While I wouldn’t call this a “major event”, the fact that a major jurisdiction can’t keep the lights on speaks volumes.

This issue isn’t solved by adding renewables onto the grid – indeed, having too many renewables on the grid with the lack of dispatchable power sources was the cause of the problem.

If my suspicion is correct, this is going to be the start of a paradigm shift on what was a dead power production market (ruined by floods of cheap capital for intermittent power sources). I can’t tell whether this comes in the form of further power price increases (see: California, Ontario, Germany, etc.), increases in dispatchable energy supply (read: natural gas, nuclear or thermal coal!), or energy restriction mandates (or a combination of all), but either way, there are obvious investment angles coming down the line.

My only other comment is there are operational implications when you allow your quasi “crown corporation” primary power supplier PG&E (NYSE: PCG) to be sued into bankruptcy due to wildfire transmission line risk – when you get into situations like this weekend, it is obvious they will be shutting down transmission grids which reduces the robustness of a power grid since they don’t want to get sued to death again in case a spark catches fire somewhere. I wonder when they will get sued for constructive negligence because they shut down transmission lines and caused a huge cascade power failure which caused even more economic damage. Companies that operate under heavy regulatory coverage in California live and die at the behest of the state – watch out if you’ve got capital in PCG equity!

A few things caught my attention today, and it is likely that means that the next few days (i.e. the short term) there is going to be some turbulence in the stock markets. If you have some leftover cash, after this storm purges some weaker holdings out of their positions, it’ll be a better time than not to load up.

First, the commodity that seemingly everybody in retail has talked about ad nauseum as the salvation to currency depreciation (gold) has cratered today:

This ~US$100 drop in gold is significant. The last time it got dumped badly was during the Covid-19 crisis where people were seeking liquidity in the form of cash at any price possible. Beyond that you have to go back to late 2016, and I think this was due to threats of interest rate normalization (does that feel like a long time ago!).

The psychology of the situation is telling. Gold was the crowded trade where everybody piled in because they were comfortable in ordering the shiny yellow metal. It was the hedge against the collapse of the currency and economy due to COVID-19. After it eclipsed $2,000/Oz, that was a catalyst for people to assume it was all systems go, and people were pronouncing price targets of $2,500, $3,000, etc., per ounce. Instead, the bottom is falling out, and the question is how low this price will have to go for the people that got in at $2,000+ to bail out.

What’s even more interesting is the rise up (some 10bps or so) of the 30-year US treasury bond:

This is not a huge rise, but it is sharp. Rising long-term interest rates have many spin-off consequences. Since the Federal Reserve effectively controls the yield curve at present, they may be pushing for larger spreads. Tough to tell at present. The assets of the Federal Reserve continue to be flat in the month of July.

I’m going to guess there will be a spike of equity volatility in the next few days that will follow this minor tremor. It will be enough to get weak hands out of the market and confuse people about future market direction – negative headlines and worries will once again permeate. A great time to deploy more incremental cash, similar to when the markets vomited in the second week of June.

There is no way for me to do this in size in Canada (Betfair would have been the best venue), so I’ll give this free arbitrage to the crowd following this site:

On most political betting sites, you can bet who will be the next president of the USA in the 2020 election. Trump is around 3:2 (bet $100, profit $150 if win), while Biden is around 2:3 (bet $100, profit $67 if win).

Legally, the Democrats have to nominate a presidential candidate very soon otherwise it becomes very difficult with regards to ballot access laws to have the name changed. During the 2016 election, the Donald Trump “grabbed her by the PXXXX” moment got a bunch of people interested in investigating the topic on how a major party candidate could be replaced on the ballot very late in the game. The conclusion is that by the end of August, things are more or less sealed up for a bunch of states and by mid-September most of the states are ‘locked in’. Courts would have to be petitioned at this point, which comes with obvious uncertainty.

It should be abundantly clear to a non-partisan observer that Joe Biden is suffering from dementia. It is getting to the point where the Democrats should be actively investigating whether they want him to be the nominee or not.

My arbitrage play at this point would be to sell Joe Biden (NOT Democratic Party) at this point and then liquidate the bet if he is formally nominated (which would be a neutral transaction, perhaps winning or losing 100-200bps or so in the process) or collecting a massive gain (100%) if the Democrats dump him from the presidential ticket. Hence the political arbitrage.

This would leave the question of who the Democrats would nominate, and that would be Kamala Harris, who you could get currently at 180:1 odds. I can’t find a place where I can legally purchase chances to win the Democratic nomination. After Biden is dumped I would then liquidate this bet (she would trade at least at 1:1 in the event of her nomination, so you would receive an ROI of around some 5000% percent in the process even if you got her at 100:1).

Betfair is closed to Canadians and would be one of the few credible venues where you can pull this off in any size. For those of you in the UK or elsewhere where Betfair is available, you’re welcome. At worst this is a neutral and at best you’ll get an ROI of 100% on your Biden “short sale”. I accept gift cards to fast food joints if you wish to express your appreciation after cashing in on this!

I took a few days out in a remote area (i.e. away from major urban centres) to do some reflection and avoiding the airwaves for the most part. It allows for mental digestion without dealing with the day to day distractions. Also, due to Covid-19, the tourism sector for the most part is decimated, which is why it is the perfect time to go out to places that would otherwise be swamped with tourists.

Covid

It’s pretty evident that nomenclature has made this much more difficult than it should be. The virus that causes COVID-19 is SARS-CoV-2. An analogy is that HIV is the virus that causes AIDS. Unfortunately, in everyday conversation, the words “COVID-19” refer to the disease and are conflated with the virus. There is ample evidence that even if you have the virus, there is a very good chance that you don’t get the disease, but the reports are still such that you are “COVID-positive”.

There are plenty of viruses out there that people are completely asymptomatic to. A good example is the Herpes Simplex virus, where it is estimated that 2/3rds of the world population has it. The disease that the virus causes is called Herpes simplex (same name as the virus).

Until people make a proper distinction between the virus and the disease, I generally believe public policy will be quite irrational in circumstances. Specifically, efforts to contain the virus by caging people and restricting various activities are effective in the short term, but pay very little to the fact that in the longer run, there will be re-infections. Jurisdictions that have claimed victory (e.g. New Zealand, Atlantic Canada, Hong Kong) will discover that the virus will re-emerge despite all efforts to contain it. This is ultimately a futile battle.

If I was pulling the public policy levers, it would be to focus on those obviously vulnerable to the disease and not the virus. As the age cohort is the dominant variable that correlates with mortality and severe symptoms, these people should continue to take extra precaution – both due to SARS-CoV-2, but also because there are a boatload of other viruses out there that also correlate positively with age in terms of mortality.

But in the meantime, we have long since passed the point where COVID-19 is used for rent-seeking and other political purposes. This is obvious in places like Hong Kong, which authorities are claiming to cite as the reason why they should shut down again (real reason – legislative elections are coming up and they won’t be good for the establishment), but also here in Canada, where incessant “mask or no mask” polarization completely misses the point – people that get the virus don’t necessarily get the disease.

This search for a vaccination is also a huge red herring, but it will serve a psychological purpose – a light at the end of the tunnel. However, my deep suspicion is that this will be similar to attempts to vaccinate against the common cold (Rhinoviruses and other Coronaviruses) and the annual “flu season vaccination” which protects against certain strains of flus (H1N1, H5N1, etc.). There is evidence to show such vaccinations do have effectiveness, but it is never a “black or white” situation – the flu vaccination, for instance, ranges in effectiveness from 10% to 50% (if you believe the evidence!), but it is impossible to measure after the fact – for ethical reasons, you can’t run a double-blind test where you purposefully infect people in one arm. Measuring something that does not happen is much more difficult – if you took the flu vaccine, but didn’t catch the disease, who is to say that you just simply never would have gotten it anyway?

So here is my prediction on the COVID-19 vaccination – there will be something released, it will be ‘proven’ to be effective, but its effectiveness will be diffuse (let’s call it a statistically significant 10% success rate). Victory will be claimed, and a whole bunch of people will take it (which will spark another public controversy over mandatory vaccinations vs. not taking them) and the world will move on.

Fundamentally, what is going on is much more simpler – we all have immune systems. Some of us are much better at fighting certain classes of viruses than others. There are some of us that have very good immune systems, and some of us that get sick all of the time. Statistically speaking, if you are young, treat your body well and have had general exposure to other amounts of viruses in your past life, your body will be well adapted to fighting SARS-CoV-2. Some will be much more vulnerable. A simple analogy is that happened to when the European explorers introduced smallpox to the native populations in North America – the natives didn’t stand a chance since their immune systems were not trained at all to fight the classification of viruses that had brewed up in the filthy urban centres of Europe over the prior centuries (prior to the advent of urbanized sewage systems, it made Chinese wet markets look very sanitary by comparison).

Another analogy is physical fitness – if you are asked to run 5km in a 75th percentile time and you haven’t done it before with zero athletic training, chances are if you actually forced do it, it would probably cause severe damage (shin splints to name the least, but it would probably cause severe cardiovascular damage). Recall the first recorded instance of a person running a marathon died after completing his mission (Pheidippides)! However, if your body is trained, you will be adapted to the stress that heavy physical activity incurs. While this simplifies matters with regards to immunology, the body that has faced a variety of viruses in the past will likely do better dealing with SARS-CoV-2 than those that are inherently sensitive.

Finally, if this virus is anything like other viruses, there will be subtle mutations that will increase and decrease the prevalence of disease – just like how you can get a “light” cold and a “bad” cold.

I really think it’s time we move on.

Investments in Markets

It is evident to me that investing in ‘stuff’ rather than ‘dollars’ is going to be the right decision. Other than some (rapidly depreciating) cash, I hold nothing financial in my portfolio. No banks, no insurers, etc.

There is currently a boom in technology-related issuers and I am content to let this segment of the market figure itself out with their high valuations. The rush to liquidity to largecap issuers (the FANGS, and throw in Tesla in there while you’re at it) are also a result of passive indexation – you throw a dollar into an S&P 500 index fund, and 20 cents of your investment automatically get forced into the top 5 or 6 companies – who’s going to sell it to you? As a result, prices rise when liquidity rises. The major indicies will likely continue rising.

It will eventually implode (analogy is year 2000) and when it does, the survivors left standing will be the ones that are actually producing real stuff. This means primary industry participants (that can actually produce such products at competitive costs as primary industries are quite competitive), but secondary industry participants that produce viable products from primary industry participants will also do quite well. I realize this is quite abstract, but I do have some names in mind.

Commodity investing

Gold is going crazy right now (and rightfully so – why bother speculating on negative interest rates with government bonds that are effectively yielding zero, when you can just get your hands on the shiny yellow metal?). I do not like any of the gold mining companies – they are all capital pits.  Their market value will go up on the basis of reserves, rather than having efficient operations and capital management.  Perhaps I’m a little too dismissive and throwing out the baby with the bathwater, but I think there are too many eyeballs on gold producers (despite most of these producers not being very well represented on the indicies). If you believe in gold, just buy the futures contracts and get price exposure that way.

Oil is a more interesting space, at least in Canada. Canadian SAGD producers (and more conventional low-decline producers) are going to be in shockingly decent shape – most of the capital has been spent and it requires relatively less maintenance capital to keep the production flowing. Contrast this to capital-intense shale producers which is now financially nonviable (and institutions are now smart to how this pricing model is no longer functional). Especially in Canada, environmental laws are incumbency protection for the major producers, and now that US shale has peaked (Q4-2019), they are going to be more reliant on imports once demand gets back up again. With Trans-Mountain continuing, Coastal Gaslink proceeding and Keystone probably continuing to fruition (maybe), it actually bodes quite well for Canada. Teck not getting into the oil sands game was probably the death knell for further oil production in Canada in the foreseeable future, which means the Suncor, CNQ and Cenovuses are going to be reaping the rewards.

My guess is we will see a triple digit oil price in a couple years. Other fossil fuels (gas, coal) will follow. It will be considered a massive surprise from market participants that thought the days of fossil fuels were done.

Again, just like gold stocks, probably investing in futures contracts are the easier method, although in Canada, most of the companies have been hacked so badly in the past decade that they are lean operations and you can pick and choose from them to get sufficient leverage (in addition to being registered account eligible).

Finally, the outlook for Coal companies right now feels like how the market felt about tobacco investing in the late 1990’s. The highest returns are to be made when an entire sector is shunned without any hint of contrarianism (which is what you see now in the airline and cruise ship industry).

Election Politics – USA

It is tough to believe the US Presidential Election is just over three months away.  Four years ago the election felt like it lasted a year.  This time around it feels like it hasn’t even started yet.

The most credible gambling site where you can throw a bunch of money at and not get defrauded (they respect wagers from people that actually are winning clients) is Pinnacle Sports.  They have Trump at +156 (39% to win) and Biden at -184 (65% to win) (note that the excess of 4% of the total of 104% is the “bid/ask spread”).  Another credible site (Betfair, but not available for Canadians) has Trump at 9/5 odds.  The basis for this is likely the litany of polling showing that Trump is down by about 9% across the country, which in most ordinary circumstances would result in a slaughter.

However, this is not any ordinary election, and the winner is determined from the electoral college and not the popular vote.  Just like in 2016, Trump is going to get slaughtered by significant margins in California and New York, but it doesn’t matter whether he loses by 40% or 20% in those states – the outcome is already pre-determined.  The question is how he does in MI, OH, FL, NC, PA.

The other question is if polling data is reliable.  In both Canada and the USA, elections are determined by who turns out to vote, and polling typically does not capture this data very well.  If I were to guess at present, I would say the odds are reversed.

Election Politics – Canada

There is a non-trivial chance of Justin Trudeau calling an election for October.  Be warned.