Monthly Archives: January 2015

Portfolio Hedging Review

In the past, I’ve written about how I buy puts on the SPY index to hedge my portfolio. Since I started doing so opportunistically about 3 years ago, I’ve found this to be rather ineffective. This could be because the markets have on the whole been on a huge upward move, with hardly any corrections. However, I do feel some dissatisfaction at wasting money on puts that almost always expires worthless.

Since November, I’ve switched to using the E-mini S&P500 futures contract instead. I’ve done a total of 6 round trip transactions. The benefits of using options was that your downside is capped at the original amount of premium you paid. The benefits of using futures on the other hand is that there’s no money spend on implied volatility, or a theoretical premium to what the protection is worth. The flipside is that you have to actively manage the position. In many ways, you are selling short futures because you think the market is going to fall, but you find it difficult to sell your stock posiitons because, for example, they are undervalued.

When calculating my performance, I’ve once against lost a bunch of money on this new tool. On closer examination, I believe I have lost less this way, than if I was to use SPY puts. I believe there are a few reasons to this. Firstly, you don’t lose time value while holding the position. Secondly, the leverage that the futures provide means that I usually only have an open posiiton of 1 contract. The leverage allows me to have a smaller position. Hence, I plan to continue to use this as a tool instead of options.

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Soybeans 2014 Review

zsx14This has been a very interesting year for soybeans. While I’ve done a fair number of trades for soybeans, this post will focus on the main trade which was to sell the SX14 (Soybeans November 2014) contract short. I made a total of 26 round trip transactions for this contract from June to October 2014.

A good friend of mine told me that the planting season had gone very well and it was expected that there would be a bumper crop during the harvest in 2014. Hence, selling SX14 short would be a good trade. However, since I’m not so close to grains as I wish, I was a little hesitant so most of my trades were short sales before USDA report releases. I also sold short SX14 when it broke $10, seeing that as a very bearish signal.

In hindsight, it would have been a much better trade to keep a short position in SX14 and adding to the position before every potential catalyst such as the USDA report release. An epic error I made was during the June report. The report announced that soybean acreage was 3 million acres more than previously thought. The market absolutely plunged and there was follow through selling throughout the session. In fact, SX14 started drifting much further down over the next few days and never went back to the level when the announcement first came out. Since I was unfamiliar with the existing situation, I didn’t have the confidence to be so aggressive and so missed most of the move and left most of the money on the table.

Having said that, shorting soybeans have been another source of profit for me this year.

Currency Trading Review 2014

2014 has been a year of firsts for me as a trader. One of them was that I started trading currencies. Thankfully, it has been a good experience so far and I’m much richer both in terms of financials and experience for it. Most of my trading has been in the USD JPY, but I also had success in EUR USD and USD SGD.

sgd

I’ve watched the USD SGD rate for a very long time. I remember that in 2007, just before the Asian financial crisis, the exchange rate was 1.45. I know this because I needed the exchange rate to calculate the value of my basketball trading cards. Since then, I’ve followed this currency pair out of interest. During the 17 years since, the USD has largely been much stronger than 1.45. It has only been in recent times after the Fed launched QE that SGD started trading far below 1.45, going as low as 1.22. I’ve looked at this trend with much scepticism, perhaps shaped by what I saw during my growing up years. Hence, I’ve been watching for a turn in the currency pair for a long time, eager to ensure most of my life savings are in the world’s reserve currency.

This turn came about last year when Bernanke told Congress that the Fed would have to start tapering soon. This roiled the currency markets and USD started strengthening aggressively. I rued my missed opportunity convert my SGD into USD as the exchange rate soared from 1.24 to 1.29. Luckily, earlier in the year, the SGD strengthened for some strange reason and went back to 1.235. While I wasn’t lucky enough to make my conversion at this low, I managed to change a large chunk of my savings at 1.24. Thankfully, that has looked to be a good decision as the USD hasn’t looked back and is now trading north of 1.32.

I see this currency conversion not as a trade to profit from, but as to which currency is a better way to store one’s wealth. However, if I was to calculate it as a trading profit, I was surprised that my gains are actually very minute on an absolute basis. This shows the importance of using leverage in currency trading since the currency moves tend to be relatively small (though there are many examples that disprove this).

In 2014, I’ve started trading two other currency pairs in my portfolio – USD JPY and EUR USD. I’ve used GLOBEX futures for this as the exchange traded futures provide both ease of execution as well as inherent leverage. Let’s first review my experience in USD JPY.

I made 16 round-trip transactions in USD JPY during 2014. But first, some background on why I started trading USD JPY. When I first returned to Singapore in 2012, I met a friend who worked at a hedge fund. This coincided with the time that the BOJ first announced Japanese QE and my friend went on and on about how we should long USD and short JPY. As a value investor, I looked at currency trading as pure speculation and with great wariness and so I politely declined to participate. Even the giant move from 77 in Sep 2012 to 102 in May 2013 didn’t tempt me. In fact, I didn’t follow the currency pair at all. It was only in Feb 2014 where USD JPY caught my attention and I started following it.

JPY

My trades can be separated into 2 distinct phases. The first is a series of 7 round trip transactions from Feb to July 2014 while the second is the other 9 round trip transactions executed in Nov and Dec 2014.

After Bernanke talked about tapering in May 2013, I started gaining interest in a strengthening USD trend. After all, I’ve always believed that the USD is here to stay as the world’s reserve currency and that it’s inevitable that the USD will be strong again at some point. This conviction strengthened in Nov 2013 when the Fed started it’s first reduction of QE. In Feb 2014, my friend mentioned that it was a matter of time that the JPY starts weakening against the USD again. The markets were just waiting for the BOJ’s next move. I immediately gained interest in the currency pair and made my first trade to short yen at 102, the level it was trading at that point of time. Between Febuary and July, I essentially scalped USD JPY, shorting yen when it went below 102 and covering the short whenever it went above 102.5. I was happy to make this little extra to juice my portfolio returns.

However, this also meant that I missed the really big moves.  In mid-Aug, the currency pair made an enormous move from 102 to 109.8, which I totally missed. I missed the second big move in mid Oct from 105 to 116 in mid Nov. This fear of following the momentum caused me to miss a big opportunity. The second move in particular was very unfortunate. My friend had texted me while I was having lunch to inform me that the BOJ had increased it’s QE program unexpectedly. But when I checked the market, the currency pair had already moved about 200 points and I decided that it was already priced in. Little did I know, the currency would move an addition 700 points in the next few days.

Missing out the big move in USD JPY made me eager to jump on the bandwagon which led me into the second phase of my trading of USD JPY. A chart, which I’ve reproduced below, that I saw in a SocGen report really influenced my thinking. Because of this chart, I waited until USD JPY reached 120.5 before I shorted yen again.

jpy 145 Unfortunately, that proved to be a most mistimed trade. Literally three days after I aggressively shorted yen between 120 and 121, the yen started strengthening and even reached 116 at one point. This was partially caused by the collapse in crude oil prices which sparked a flight to safety in the yen since Japan is a huge net importer of oil and is also traditionally seen as a relatively strong currency. Thankfully, I weathered the dip and my trading of the USD JPY currency pair has been a net positive for me in 2014.

eur The last currency that I’ve traded in 2014 is the EUR USD currency pair. I only started trading this pair in late November as I was looking for another way to express a bullish USD position instead of USD JPY which I feared had already run its course. In that time, I made 10 round trip transactions but at a much smaller profit per transaction. This makes sense as I tend to be very jittery when trading a new product so I take profit at much lower levels. Hopefully, my experience so far has made me confident enough to make bolder moves in 2015.

Crude Oil 2014 Review

I started trading crude oil for the first time in 2014. I made 16 round trip (buy and sell) transactions in Brent and 13 round trip transactions in WTI. Not bad for someone who didn’t even know the ticker symbol for either contract in end November. Moreover, I’ve traded double the number of crude oil contracts in a little over amonth compared to the number of USD JPY contracts over the whole of 2014!

A quick review of my transaction history shows my strategy. While I may spend a fair bit of time reading about the crude oil market, the fact of the matter is that I’m too far away to get accurate real time data. Even if I could, I wouldn’t know enough to actually trade on the data or news effectively. Hence, I have to trade very opportunistically and keep each trade open for a short period of time. This is shown especially during my trades on the 27th Nov 2014, the day of the OPEC historical OPEC announcement.

The lead up to the OPEC announcement was what got me interested in trading oil in the first place. Oil had already dropped about 30% between the June highs and 27th November. There was a fair bit of press about the announcement which drew my attention. What I read argued that Saudi Arabia would lead OPEC to cut production so as to support prices. Since it was a fairly inactive day at work, I chanced upon an investment bank’s take on the OPEC meeting which vehemently argued that OPEC would not cut. That contrarian call drew my attention and I started to follow a bit more closely. As the day went on, I read more news from Reuters and the like that OPEC was not going to cut. While crude oil was falling slightly, I saw this as a trade that had a clear catalyst in a few hours time and so I took a punt to short my first ever Brent contract.

As the announcement drew near, I realized that it would be best if I could hear the announcement live myself. I discovered that OPEC had a live webcast and so I tuned in. In the 30 minutes before and after the announcement, it sure was one volatile ride with both Brent and WTI falling and rising without much reason. Being jittery, I opened and closed contracts as the market swung, fearful that there was some news that I was unaware about. In total, I made a total of 10 round-trip transactions during that 1-2 hours! When the official announcement came and when the press conference was over, I closed all my positions. This was actually a big mistake as oil would start really moving again about 1 hour after the whole press conference was over. However, I didn’t want to have any risk on the table while I was sleeping. This taught me a lesson that often times, the market takes a while to react while the news sinks in.

In the days after the OPEC announcement, I watched with dismay as oil continued its plunge and I didn’t have any positions. However, when there was significant news, such as when my Bloomberg App notified me that Saudi Arabia had further cut prices to Asia, I immediately took it as an opportunity to sell a few contracts short and try to ride it down a little.

Looking back at the transaction data, the average difference between my short sales and my buys is less than $1. This is made up by the number of transactions I made. Overall, crude oil has been a source of profit for me. Given that my portfolio is meant to be in equities, this has certainly been a source of alpha for me. While I hope that I will gain more insights into the crude oil market, I doubt that I will be able to trade it successfully for much longer, once this current uncertainty is resolved. However, I believe that the lessons I learn from trading crude oil will be applicable if I was to trade any other futures market.

Crude Oil Thesis for 2015

Anyone who hasn’t been living under a rock knows that crude oil prices have absolutely plummetted in 2014. Oil prices experienced their second largest annual decline ever and ended the year at a 5 1/2 year low. West Texas Intemrediate crude (WTI) fell 46% for the year while Brent fell 48% for the year. Many analysts predict a quick recovery in oil prices back to the $70 region but I beg to differ.

Let’s assume no new shocks to supply or demand such as a huge middle east crisis that cuts supply immediately, or OPEC calling an emergency meeting and saying they are going to drastically cut production to support prices, or China suddenly achieves 10% growth and starts buying up the world’s oil like what it did previously with iron ore and copper.

If the above stays true, then I believe oil has a very high chance of falling lower. I wouldn’t be surprised if WTI reaches low $40s, and Brent mid to high $40s. Most analysts, especially those at banks who cover equities, think that oil has bottomed and will recover, probably by end of next year. While it could be true that oil will start recovering by end of next year, I do not believe that it has bottomed. The bulls’ thesis is that most US shale wells have a breakeven of >$70-80 so they will cut production and new wells will stop being opened. However, they are confusing the breakeven price for greenfield projects and for mid-stage/cycle projects (projects that have already started). Yes, in many of the shale basins except for maybe parts of the Marcellus, Bakken and Eagle Ford basins, it is uneconomical to buy land leases, apply for the permits, buy the equipment and start drilling. However, if the process has already been started and lets say the land has already been bought for example, the company is still going to proceed with the project to get back some return. After all, whatever investment it has already made is sunk and they need to continue the project to get back some cashflow, probably to service some debt. Hence, the US shale supply will take quite a bit longer to start responding to this lower price of oil.

The above analysis assumes that OPEC (Saudi Arabia) is trying to achieve economic aims. There’s another argument that Saudi Arabia is actually looking at this from a political angle (which it has had a propensity to do so, as recently as 2008). Saudi Arabia fears USA’s rapprochment with Iran. By depressing oil prices, Iran’s influence is significantly curtailed since their budget deficit is going to be so large. Some point out that Saudi Arabia also needs a brent oil price of ~$100 to balance it’s budget, but they forget that Saudi Arabia, along with Jordan and Kuwait, have built up reserves equivalent to more than 5 years of their annual budget expenditure. Hence, they are able to endure through this short term pain and this means that prices can stay low for an even longer period of time.

So far, we have talked about the fundamentals of the oil market. The stocks situation of oil is definitely still building, and this can be seen in the forward curve of both brent and WTI, where the contango has widened. One problem of futures curves though is that they tend to reinforce the flat price trend. So in this case, as the contango widens, it gets more and more costly to be long the front end of the curve because of the negative roll yield. Thus, many longs will be slowly forced to cut their position. This long liquidation will act as a further overhang in the market, until a positive shock to supply or demand emerges. Potential new longs will stay away due to the higher cost of carry. I think a good analogy of this is a poker tournament where a player is busted out not because he lost money in a pot, but because he kept having to pay blinds. Moreover, the prices of both WTI and Brent have been consolidating the past 2 weeks, and at times have actually bounced a bit (though very briefly). From the commitment of traders report, we can learn that this is due to new long positions from non-commericial players (basically funds). I feel that if oil starts falling a little or shows no sign of recovering soon, then these longs will liquidate and move their money elsewhere. This will serve as a second overhang.

Thus, I’m very bearish on oil, both from a fundamental and technical point of view. I think it will fall further and not recover until late next year at the very earliest. I recommend any bounce as an opportunity to sell. I’m happy to sell short both WTI and Brent crude futures. However, if I had to pick between the two, I would choose to short WTI. US crude stocks should continue to accumulate as shale oil production is maintained in 1H15. Brent futures also run the risk of being more impacted by a supply shock in the world such as a middle east supply disruption.