Shorting Volatility In The Midst Of Fear

All hell seemed to break lose last week, as the S&P recorded it’s worst week since the GFC back in 2008.

Yup, that’s the worst week ever in more than a decade, which also means that the sharp and rapid drop would’ve taken most market participants by surprise. Many newbie or less experienced investors would be caught in a web of emotions (mainly fear), as this is something they’ve never experienced before.

The indices dropped ferociously every single day for the entire 5 trading days of the week, and with almost every major global index being sharply down, many investors would’ve found their fortunes severely decimated within the mere span of 5 days.

DJIA dropped 12% within the week, and the 10 year treasury yields dropped to a record low, as the flight to safety came back with a vengeance

Already, globally, we are seeing negative forecasts popping up, with many forced to revise their previously, ridiculously optimistic views. Here in SG, it’s already forecast that Q1 would experience a contraction at -0.6%.

So yeah, in summary, it’s not a pretty sight.

In response, the volatility index (VIX) went ballistic within the week, reaching it’s highest since 2011.

925) VIX

With this, I’ve just initiated short positions on volatility, selling calls on VIX derivatives.

In essence, the thinking behind this is not difficult to understand.

Market’s fear of unknown and uncertainty grows exponentially. When we try to extrapolate our emotions further out into the future, it’s usually a poor estimate of what actually transpires.

This means that when we are pessimistic, the reasons and rationale for being pessimistic are usually very much true in the short term, but further out, they tend to be overly pessimistic.

Yannis Couletsis of Credence Capital is doing something similar:

“The director at Credence Capital, the volatility-trading arm of KM Cube Asset Management with 150 million euros ($164.2 million) under management, is betting that the fear gripping global markets will prove short-lived. He’s selling options to anxious investors who have sent the price of the derivatives soaring in an attempt to shield themselves from further pain.”

“The logic behind the strategy is received wisdom among derivatives traders but a puzzle to the uninitiated. It’s known as the volatility-risk premium, or the tendency of investors to demand higher compensation for future uncertainty compared with what actually comes to pass.”

““We are confident in our system’s signals,” he said. “Volatility is mean-reverting in nature. All our indicators signaling short-vol positions are still on.””

Only difference is that TTI is not so heroic to put 65% of my portfolio to work doing this.

It’s going to be a very reasonably small position.

As long as the indices don’t drop another 12% within the next week, I’d be alright.

Premiums for all puts have obviously gone ballistic in the past week, and accordingly, the premiums for VIX derivatives have gone ballistic as well.

Shorting VIX derivatives with costly, very much expensive puts is a fool’s game to me, so shorting naked calls is the way to go.

Aside from the erosion of time premiums being a MOS, I’m betting that we don’t experience yet another 15% decline in the next week, and another 15% decline in the week after. Cos afterall, nothing goes down in a straight line. (except in cases of fraud)

I’d also state that in the midst of all this fear, I’ve already started adding to long positions, as per the plan previously:

TTI’s Top 5 Generals

New, trial portfolio is down YTD, just like the main portfolio, and probably just like almost everyone else, but I’m optimistic as some parameters that I’m tracking are looking strong.

Will likely post quarterly updates when the time comes.

Good luck to all.

Guest Post: Visa By Datascienceinvestor

Title’s self explanatory…

“J” from Datascienceinvestor asked to exchange guest posts, but since I hardly bother to post much myself here these days, I declined, but offered to give him a guest post instead.

“J” asked for suggestions, and since my last post was on the top 5 generals for my new fund, I suggested any 1 of the 5 names and he picked Visa. (TTI’s Top 5 Generals)

So without further ado, go check his site out. I did, and it’s……. different, I guess. Something refreshing for a change. See if you find this useful.

Some of the numbers and figures in the post may be slightly off, that’s not a mistake on the part of the author, but rather, simply cos I’ve been a bit tardy in posting this.

Visa’s share price has risen substantially since the author wrote this. But still, most of the data should be relevant enough.

Stock in focus: Visa

This is a guest post by datascienceinvestor. You can find his blog here.

919) Visa

Visa (Symbol: V) is probably a company that almost everyone knows. For most of us, we utilizes its services in our everyday life. So for the uninitiated, what is Visa’s business?

Visa is a global payments technology company which aims to connect between several groups such as government, financial institutions, businesses and consumers. Its business model is really simple. It simply just manages and operates its electronics payment network (now I may be oversimplifying it here, but trust me it’s not too complicated). And the best part of having a simple business model is that it is also usually a very profitable business model.

In this electronics payment space, there aren’t too many competitors, with the closest competitor for Visa being Mastercard. These two companies enjoy a duopoly status in the electronics payment space and have built such an impregnable moat that it’s very difficult for any other company to take significant market share away from them. With the world moving towards cashless transactions, there are many more good days ahead for Visa and Mastercard.

Now, back to Visa. How has the stock price performed in the past year?

920) Visa share price

Pretty decent, isn’t it? It’s on a constant uptrend for the past year.

How does it compare against the major US indices such as DJIA then?

921) Visa relative performance

Now, the r coefficient for the trend lines for both Visa and DJIA can be seen in the graph above. So what does r coefficient means? r coefficient is used in statistical analysis to explain the strength of the linear relationship between 2 variables. Since we are using price and date as the variables, r coefficient allows us to better understand how the price changes with time. In this case, the higher the r coefficient, the better the price performance. Hence, we can see clearly here that Visa has a better price performance than DJIA. This also goes to show that you will reap in a bigger profit if you are to buy and hold Visa instead of DJIA for the past year.

I like to touch on a bit on Sentiment Analysis here as it is increasingly used in various domains to better understand the effects of people sentiments on various other factors/outcomes. In stocks investing, this area of data science is becoming increasing important. Sentiment Analysis is usually applied in stocks investing to better understand if people sentiments has any effect on stock prices. In this case, I will attempt to try to assign a quantitative value to people sentiments on Visa to see if there is a direct correlation between people sentiments and Visa’s stock price.

In this case, I extracted Visa sentiment data from Sentdex which pulls data from a variety of sources such as Reuters, Yahoo Finance, Bloomberg, Forbes etc and assigns a value to the general sentiment on a particular topic everyday.

Here is the scale, ranging from a value of -3 (strongly negative) to 6 (strongly positive)

6 – Strongest positive sentiment

5 – Extremely strong, positive, sentiment

4 – Very strong, positive, sentiment

3 – Strong, positive sentiment

2 – Substantially positive sentiment

1 – Barely positive sentiment

0 – Neutral sentiment

-1 – Sentiment trending into negatives

-2 – Weak negative sentiment

-3 – Strongest negative sentiment.

To ensure higher accuracy in the data value, I use the Simple Moving Average of the sentiment value across a period of 5 days instead.

Here is how it looks like (as an example)

922) Visa sentiment analysis

Now, let’s take a look at how its sentiment value looks like over the past 1 year.

923) V sentiment value

For most parts of the last year, the sentiments for Visa has been rather positive except for the current period (when its current results missed on revenue expectations– causing the sharpest drop in sentiments in the past year) and the period between Nov 2019 and Jan 2020 (likely due to the looming near term headwinds of 5% increase in tariffs on Chinese imports scheduled on Dec 15 back then).

How has Visa sentiment analysis correlate to its price performance then? Here is the graph.

924) V

The r coefficient for the trend line is a mere 0.0564 which suggests that sentiments has very little or almost negligible effects on its share price over the course of past year. Hence, sentiments analysis can be taken out of consideration when analyzing the various factors influencing the stock price for Visa. This is very unlike some of the tech stocks such as Nvidia which relies heavily on sentiments.

On the fundamental side, Visa’s PE ratio of 36.8X is now higher as compared to the industry average of 32X. Its PB ratio of 14.5X is also much higher than the industry average of 4.2X. Hence, I wouldn’t say that Visa is a value stock right now based on these factors.

However, if you are looking at a stable stock to invest in, Visa could be very well on your watch list. Its debt is well covered by its operating cash flow (coverage of around 76%) and interest payments on its debt are also well covered by its EBIT (almost 54X). Historically, the stock has always been on a steady rise with very minimal occasions when it suffers a great price drop. If you are in it for the long term, you may like to consider either buying on the dips on just simply dollar cost average in your purchases.

Hope this has been informative!

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