Monday, April 20, 2009
Pepsico Bids to Acquire Stock of Its Bottlers: Risk Arbitrage Activity
Some stock operator out there has a bit of info that the rest of us don't have, because both PAS and PBG, which are Pepsi bottlers, are trading well above Pepsi's bids. PAS stock has almost a dollar in premium and PBG is not far behind.
White House Announces More TARP Conditions: Stock Markets Hear More Vagaries
The Obama administration just announced a further "quality test" for US banks who received government bailout money. These banks will only be allowed to pay-back money they received during the stock market turmoil if they pass a further unspecified test of their capital ratios. That means if the treasury deems that a particular bank does not have enough capital, it will not be allowed to pay back the TARP money.
This could have major implications on the stock market prices for any bank that is part of the test. Just like the previously announced bank stress test, this new test lacks specifics and may segregate banking sector stocks into two groups: those deemed by the government to have enough capital and those stocks that do not. This may place a psychological price premium on banking stocks that pass the government's tests.
The government is providing the setup for a short term panic when these tests are finally enacted. The administration has been so vague in a time when certainties are prized above all else. In a place like the stock market, especially one that has recovered so vigorously in a small period of time, this prolonged uncertainty from the most powerful financial institution in the world is just pain dangerous. The stock market will be watching the outcome of these stress tests closely.
Saturday, April 18, 2009
What Government Stress Tests Mean for the Stock Market
Ever since the Obama administration took office, the stock market has waited for the treasury to conclude its much talked about "bank stress tests." The tests are designed to determine which banks need more capital and thus which stocks are likely to sell off.
When a bank needs to raise capital, it usually mean existing shareholders will get diluted. The bank either has to get more money from selling stock (which makes the price go down) or by selling debt (which makes servicing old debt harder). That means the stock market is watching the outcome of these tests with baited breath.
Given the stock market's 20% bounce off the march bottom, some view this as a time to be cautious. If the bank stress tests turn out poorly, the market may be in for a correction. But the government has a vested interest in keeping the banks solvent. This is because the taxpayer has become the de facto shareholder through the market bailout plan. The administrations unwillingness to release the results may be an attempt to make sure everything looks as good as possible.
Friday, April 17, 2009
Stock Market Investing Fundamentals
So you have decided that you want to get into stock market investing, but where do you start learning the market? As recent market events have shown, learning to invest in stocks is hard. This is true even for the professionals. So how can someone reading stock market for dummies go from losing money gambling to ruling the stock market?
The keys to successful investing are motivation, discipline, and stock market timing. You have to be motivated to learn investing from stock market professionals who have stood the test of time. You have to read voraciously, consuming stock market information constantly. It is this stream of investment knowledge that will form the basis of your stock market decisions. Watching how a stock responds to your actions in the market will help you learn about what investing theories will work for you.
Once you find a consistent investment strategy, it will be your effective use of discipline which will keep you honest to what works. Just like in the casino, when you make money investing in stocks you tend to get cocky. The feeling that you have transcended dummy status and reached market god is irresistible. Investment mistakes will be made and you will come crashing back to stock market reality. This is how you will learn to invest with discipline: with pain and suffering.
Stock market timing is the hardest technique to learn and master. Even professionals only make money 60% of the time, so the ability to survive with market timing is paramount. Stock market timing involves using past prices to forecast future returns, and is thus subject to alot of speculation. Some people use technical analysis to foresee the stock market future... and some use the fundamentals. Whichever you choose is up to your personal investment style.
The keys to successful investing are motivation, discipline, and stock market timing. You have to be motivated to learn investing from stock market professionals who have stood the test of time. You have to read voraciously, consuming stock market information constantly. It is this stream of investment knowledge that will form the basis of your stock market decisions. Watching how a stock responds to your actions in the market will help you learn about what investing theories will work for you.
Once you find a consistent investment strategy, it will be your effective use of discipline which will keep you honest to what works. Just like in the casino, when you make money investing in stocks you tend to get cocky. The feeling that you have transcended dummy status and reached market god is irresistible. Investment mistakes will be made and you will come crashing back to stock market reality. This is how you will learn to invest with discipline: with pain and suffering.
Stock market timing is the hardest technique to learn and master. Even professionals only make money 60% of the time, so the ability to survive with market timing is paramount. Stock market timing involves using past prices to forecast future returns, and is thus subject to alot of speculation. Some people use technical analysis to foresee the stock market future... and some use the fundamentals. Whichever you choose is up to your personal investment style.
Wednesday, April 15, 2009
Stock Market Investing Like the Pros: Arbitrage
So I'm gonna attempt to explain some statistical arbitrage (or stat arb, in the truncated parlance of the street). Depending on your experience level, your reaction to this post should range from "duh" all the way through "well uhh" straight through to the "what the fu..." Its OK, you're gonna make it, I promise. Just stick with it and you will come out a smarter person on the other side.
In finance, there are many assets which seem to be driven by the same process. The fate of a collection of oil companies will rise and fall with the price of oil. A parent company may make record profits only if its partially owned subsidiary company gets a new contract. Or it could be something as simple as company A owns a 20% stake in company B. For whatever reason, there are plenty of examples of how the price of two seemingly different assets are linked together. When an educated investor sees two stocks moving together, he should know that there is an opportunity for profit.
Asset prices that move in concert are known as "cointegrated." Although this term has a technical definition, the intuition is straightforward. If the price of an asset rises, we would expect the price of its cointegrated partners to be rising as well. If prices are not moving together, it is because of some temporary anomaly. Thus an investor can profit by buying one cointegrated asset and selling another.
In particular, suppose we have two related assets- A and B- and we observe A rising and B falling. The arbitrageur can then sell A and buy B. Now he has a "market-neutral" position. Theoretically he does not care what direction the market as a whole takes because he is both long and short.
The investor above is betting only that the spread between the two cointegrated assets will narrow (long and short at the same time is known as a spread) . This will occur if A decreases more than B decreases or if A increases less than B increases.
For example, suppose we're long 100 shares of B and short 100 shares of A. If the market increases, its likely that our two stocks will also increase. We will make profit if the money we make in one side of the spread is more than we're losing on the other. If A rises 2 points and B rises 2.5 points, we will have lost 200 on the short position and made 250 on the long position, netting out to a profit of 50 dollars. Else, if A rose 3 points, we would lose 50 dollars.
It is important to note that a trader can make a spread out of any two assets. You could go long gold and short gasoline for example. But it is the idea of cointegration that makes the above spread so powerful. If two assets are truly related, then the spread will eventually narrow, netting the stat arb a profit.
The risks are twofold. The first is that the spread will increase so much in the short term as to bankrupt the arbitrageur before the relationship returns to normal. This is a very real risk, especially if leverage is involved. The second risk is that the relationship will cease to exist. Perhaps company A dumped its holdings of company B. Maybe company A had a corrupt CEO who embezzled billions and takes the equity to zero overnight. Either way, the fortunes of the two companies could diverge quite strikingly.
On the whole, the cointegration trading described above is useful only for calm and stable markets. But risk profiles can be adjusted for any market. In a benign market, this strategy would seek small but frequent intraday returns. The stat arb would thus make alot of trades to capitalize off of low volatility in the size of the spread itself. In a crazy market like we have now, the number of trades would be cut down dramatically. Spreads have gotten very volatile, and opposing small moves could send one to the poorhouse. Waiting for spreads to widen significantly is the only way to implement this strategy in a high volatility marketplace.
In finance, there are many assets which seem to be driven by the same process. The fate of a collection of oil companies will rise and fall with the price of oil. A parent company may make record profits only if its partially owned subsidiary company gets a new contract. Or it could be something as simple as company A owns a 20% stake in company B. For whatever reason, there are plenty of examples of how the price of two seemingly different assets are linked together. When an educated investor sees two stocks moving together, he should know that there is an opportunity for profit.
Asset prices that move in concert are known as "cointegrated." Although this term has a technical definition, the intuition is straightforward. If the price of an asset rises, we would expect the price of its cointegrated partners to be rising as well. If prices are not moving together, it is because of some temporary anomaly. Thus an investor can profit by buying one cointegrated asset and selling another.
In particular, suppose we have two related assets- A and B- and we observe A rising and B falling. The arbitrageur can then sell A and buy B. Now he has a "market-neutral" position. Theoretically he does not care what direction the market as a whole takes because he is both long and short.
The investor above is betting only that the spread between the two cointegrated assets will narrow (long and short at the same time is known as a spread) . This will occur if A decreases more than B decreases or if A increases less than B increases.
For example, suppose we're long 100 shares of B and short 100 shares of A. If the market increases, its likely that our two stocks will also increase. We will make profit if the money we make in one side of the spread is more than we're losing on the other. If A rises 2 points and B rises 2.5 points, we will have lost 200 on the short position and made 250 on the long position, netting out to a profit of 50 dollars. Else, if A rose 3 points, we would lose 50 dollars.
It is important to note that a trader can make a spread out of any two assets. You could go long gold and short gasoline for example. But it is the idea of cointegration that makes the above spread so powerful. If two assets are truly related, then the spread will eventually narrow, netting the stat arb a profit.
The risks are twofold. The first is that the spread will increase so much in the short term as to bankrupt the arbitrageur before the relationship returns to normal. This is a very real risk, especially if leverage is involved. The second risk is that the relationship will cease to exist. Perhaps company A dumped its holdings of company B. Maybe company A had a corrupt CEO who embezzled billions and takes the equity to zero overnight. Either way, the fortunes of the two companies could diverge quite strikingly.
On the whole, the cointegration trading described above is useful only for calm and stable markets. But risk profiles can be adjusted for any market. In a benign market, this strategy would seek small but frequent intraday returns. The stat arb would thus make alot of trades to capitalize off of low volatility in the size of the spread itself. In a crazy market like we have now, the number of trades would be cut down dramatically. Spreads have gotten very volatile, and opposing small moves could send one to the poorhouse. Waiting for spreads to widen significantly is the only way to implement this strategy in a high volatility marketplace.
Tuesday, April 14, 2009
Sector Trading: A Primer
One of my favorite stock trading setups is to watch an entire group of competing stocks. If there is a market leader, you can watch that stock and trade the laggers to make a quick scalp. This makes money because of the existence of statistical arbitrageurs who keep a sector in line.
Take the agricultural chemicals stocks, for example: POT, MOS, AGU, TRA, CF, MON. Using a statistical technique known as a minimum spanning tree, we can establish POT as the "leader." AGU is the closest lagger behind POT.
So in the beginning of the day, if POT is ripping you can buy a little AGU and have a positive expected value of your return; as long as POT keeps going you can book profit in AGU. The same works on the downside.
Do your own research; look at some good charts to verify what i'm saying. use some stats packages to establish a theoretical price for POT given AGU. the best approach is a combination of the two.
Where the Next Bubbles Will Come From and How They Will End
One of the biggest problems with our current financial system is the fact that lower interest rates -- or the reasonable expectation of falling future interest rates -- encourages overinvestment. This inevitably leads to speculation and a subsequent asset price bubble. As Kindleberger states in his timeless "Manias, Panics, and Crashes" over trading through speculation will be followed by a "CONVULSION." Oftentimes this is some outside news factor that suddenly makes the boom model untenable.
In the case of the current crisis, the exogenous news factor was the pricking of another asset price bubble: the housing market. When ripples from the housing bust hit the banks of the world, it created a chain reaction. While our banks lost lots of money on their crappy mortgage exposure, their losses were dwarfed in magnitude by those experienced in the subsequent world stock market carnage. Some 30 TRILLION DOLLARS of wealth evaporated in 2008. But how much was made on the way up? Considering the current boom can be traced to the 1970's 30 trillion is just a drop in the bucket.
One lesson must be leaned from the thousands of years humans have used money and trade to lubricate their lives. Markets will have booms. Booms will lead to busts. But when the rate of interest is near zero percent: the urge to lever up will become too great.
Somewhere, sometime in the future, some trader at some bank will figure out that he can borrow from the fed for zero percent and lend for two percent. He will make a huge bonus and all his trader friends will do the same type of trade. The next year many traders will leave this bank and go to other banks and hedge funds. There they will tell tales of their trade, and they will borrow money at zero percent and lend money at two percent. Except when EVERYBODY does this, we will have another credit bubble.
The money lent out at 2% won't just sit in a drawer some where. It will be invested in some asset. If the speed at which money is being lent creates more money that needs to be invested than the supply of existing assets, prices will rise. But we can't use classical economics here. This is because while the supply of assets will certainly increase from bankers hocking IPO's and new bond issues, financial assets are not normal goods.
When a normal good or service rises in price, people consume less of it. When the price of a stock goes up, more people want to buy it. They see others making a killing and want a piece of their own. Likewise, when prices go down people sell more: they don't want to lose even more money. This means that credit bubbles become unstoppable reinforcing "virtuous cycles." These, of course, are followed by horrifying unrelenting market declines (vicious cycles).
Prices will stabilize. Money will be relent at too low interest rates. Money will be borrowed by firms and investors which will push up asset prices. More money will be lent. Some will go to increased demand for borrowed funds by speculators. They want to take advantage of rising prices. More money will be lent...
In the case of the current crisis, the exogenous news factor was the pricking of another asset price bubble: the housing market. When ripples from the housing bust hit the banks of the world, it created a chain reaction. While our banks lost lots of money on their crappy mortgage exposure, their losses were dwarfed in magnitude by those experienced in the subsequent world stock market carnage. Some 30 TRILLION DOLLARS of wealth evaporated in 2008. But how much was made on the way up? Considering the current boom can be traced to the 1970's 30 trillion is just a drop in the bucket.
One lesson must be leaned from the thousands of years humans have used money and trade to lubricate their lives. Markets will have booms. Booms will lead to busts. But when the rate of interest is near zero percent: the urge to lever up will become too great.
Somewhere, sometime in the future, some trader at some bank will figure out that he can borrow from the fed for zero percent and lend for two percent. He will make a huge bonus and all his trader friends will do the same type of trade. The next year many traders will leave this bank and go to other banks and hedge funds. There they will tell tales of their trade, and they will borrow money at zero percent and lend money at two percent. Except when EVERYBODY does this, we will have another credit bubble.
The money lent out at 2% won't just sit in a drawer some where. It will be invested in some asset. If the speed at which money is being lent creates more money that needs to be invested than the supply of existing assets, prices will rise. But we can't use classical economics here. This is because while the supply of assets will certainly increase from bankers hocking IPO's and new bond issues, financial assets are not normal goods.
When a normal good or service rises in price, people consume less of it. When the price of a stock goes up, more people want to buy it. They see others making a killing and want a piece of their own. Likewise, when prices go down people sell more: they don't want to lose even more money. This means that credit bubbles become unstoppable reinforcing "virtuous cycles." These, of course, are followed by horrifying unrelenting market declines (vicious cycles).
Prices will stabilize. Money will be relent at too low interest rates. Money will be borrowed by firms and investors which will push up asset prices. More money will be lent. Some will go to increased demand for borrowed funds by speculators. They want to take advantage of rising prices. More money will be lent...
Monday, April 13, 2009
The Opening Bell Effect
There is the most trading volume per second during the first and last thirty minutes than during any other point in the day. This means that if you are a fund manager, or large investor, or whale you want to buy/sell during the opening or closing of the market in order to maximize the amount of your inventory that you can accumulate/liquidate.
For example: assume that during 9:30-10:00am you could sell 5 million shares while depressing the market two dollars. During 10:00-10:30 that 5 million would move the stock 10 points. When do you want to sell it? Exactly: during the open. Since you can buy/sell more off the open, price becomes a non-factor. Moving stocks up or down a few percent is a function of how much size people have to accumulate (buy) or distribute (sell) at any given moment.
Since the open and close represent the greatest opportunity for large shareholders to enter and exit quickly, you will always see large orders towards the opening and close of the market.
For example: assume that during 9:30-10:00am you could sell 5 million shares while depressing the market two dollars. During 10:00-10:30 that 5 million would move the stock 10 points. When do you want to sell it? Exactly: during the open. Since you can buy/sell more off the open, price becomes a non-factor. Moving stocks up or down a few percent is a function of how much size people have to accumulate (buy) or distribute (sell) at any given moment.
Since the open and close represent the greatest opportunity for large shareholders to enter and exit quickly, you will always see large orders towards the opening and close of the market.
Subscribe to:
Comments (Atom)