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Modern Trader Issue 536 October 2017

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6 Power
7 Analysts’
on Amazon
Trade Ideas
45th Anniversary
“Best Business Magazine”
The essential joystick for active investors since 1972
— Niche Media Awards 2017
On the path
to a $500B
market cap
is it
for retail?
10.17 • issue 536
Binarys, Weeklys,
Volatility, ETFs & more
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10.17 • Issue 536
Options on ETFs
Put a Cap in Drawdowns
Weekly Options: A More Precise Tool
Binary Options are Here to Stay
Volatility as an Asset Class
. . . are growing, and so are ETFs that
offer exposure to options strategies.
Put writing indexes provide risk-adjusted
retuens over long timeframes.
Options allow traders to take a more
defined position on an underlying stock;
Weekly options take this benefit one
step further.
Binary options are offered in several
regulated markets to allow retail traders
an easy way to access market moves.
New tools for institutional
& retail traders
Breaking up Amazon:
It’s Not That Simple
Amazon’s effect on the economy has
been dramatic and there are legitimate
antitrust concerns.
Closing Tick
Finding long-term success trading
Revenge of the humans
Cover by N E Torello
Min’s Magazine Media Award: Best Single Magazine Issue (January
2017—Cannabis) Nominee • Min’s Magazine Media Award: Best
Cover Design Portfolio, Nominee • Nichee Award: Best BusinessTo-Business Magazine Of The Year 2016 • American Society Of
Magazine Editors People’s Choice Award: Best Political Campaign
Cover Of 2016 • Min’s Magazine Media Award: Best Feature Article
(July 2015-Sell Stocks Now) Nominee & Honorable Mention • Folio
Eddie Award: Best Editorial Full Issue Business, Banking & Finance (July
2015—Premiere Issue) Nominee & Honorable Mention
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October 2017
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M o d e r nTr a d e r. c o m
Volatility is not to be feared. It is to be captured
and turned to your advantage. Harnessed to seek
drive income generation. Volatility does more
uncovering new and powerful outcomes.
4RADEÏITÏWITHÏ#"/%Ï6)8 options and futures.
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investors are strongly encouraged to closely read and understand the ODD and the VIX options FAQ at and other informational material before investing. No statement within this ad
should be construed as a recommendation to buy or sell a security or futures contract or to provide investment advice. CBOE,® VIX® and Execute Success® are registered trademarks of Chicago Board Options Exchange, Incorporated
(CBOE). S&P® and S&P 500® are registered trademarks of Standard & Poor’s Financial Services, LLC and are licensed for use by CBOE and CBOE Futures Exchange, LLC. Standard & Poor’s does not sponsor, endorse, sell, or promote
any S&P index-based investment product and Standard & Poor’s makes no representation regarding the advisability of investing in such products. © 2017 CBOE. All Rights Reserved.
10.17 • Issue 536
Daniel P. Collins
Managing &
Digital Editor
Yesenia Duran
Features Editor
Garrett Baldwin
Paper Trade
Options Basics
Chart Patterns
Trading Bearish
Shark Patterns
Trading Social Media
Sentiment Indicators
A technical gold play
Chipotle: New health
outbreak, new short
More upside
to Amazon?
Do airline stocks have
room to soar?
Retail’s revenge
Amazon, crude,
gold & the big
equity short
Beans, cocoa & cattle
Can Amazon
keep this pace?
Summer Weather Rally
Primes Premium
The Bonus Trade
Advanced Technique
Trading Weather
driven Grain Markets
Appreciating scotch
The Macallan virtual
reality experience
Save your season
with these Fantasy
Football picks
Big money
thinks small
Editor’s comments on
this issue & key
industry trends
finance & politics
Amazon’s next
North Korean tension
& the return of
Short Interest
Real talk on business,
Spin-offs outperform
Opening Bell
Tracking Stock
Snapchat falters
Steven Lord
Murray A. Ruggiero, Jr.
Assistant Editor
Tamarah Webb
Creative Director
Nicholas E. Torello
Advertising Sales
Barry Weinberg
Financial Ad Solutions
Richard Holcomb
Non-Endemic Ad
Chief Content
Officer & Publisher
Jeff Joseph
Modern Trader
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October: Volatility
We welcome your comments and suggestions at
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October 2017
M o d e r nTr a d e r. c o m
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6 Power
Issue and industry insights
from 28-year trading industry veteran
Dan Collins, editor in chief.
The evolution
of options
7 Analysts’
on Amazon
Trade Ideas
45th Anniversary
“Best Business Magazine”
The essential joystick for active investors since 1972
— Niche Media Awards 2017
On the path
to a $500B
market cap
is it
for retail?
A year ago in our options issue
(September 2016) we focused on the
history and versatility of options. Here, we
spend more time on their evolution and
growth. When listed options were first
launched, only calls existed and ordinary
traders could only buy an option. Today,
there are options listed on virtually every
underlying, from equities to futures to
10.17 • issue 536
exchange-traded funds. You can trade
long-dated options, Leaps, or options with
weekly expirations, and traders of all levels,
from retail to institutional, use both long and
While many professional options traders
short options positions.
have evolved from pure naked option
Options can be used to create distinct
writing, the strategy has had a rebirth with
trading strategies and those strategies
both professional and retail traders thanks
are the basis for unique investment
to historically low and continually shrinking
products. In “Options on ETFs & ETFs
volatility. This has some people worried
on options” (page 28), we discuss the
about what will happen when volatility
intersection of options and ETFs, with
returns for an extended
listing agents creating
period. Also, in “Binary
investment products
“Traders of
options are here to
based on Chicago Board
all stripes are
stay” (page 38), we
Options Exchange
(CBOE) strategy
using all of the discuss the evolution and
growth of these unique
benchmarks. “PUT a
tools in the
cap on drawdowns”
options tool
Last month we
(page 32), examines how
touched on the breadth
these benchmarks have
of disruption caused
performed throughout
by Amazon, as several experts we spoke
the years.
to cited how the Amazon revolution has
What has become clear is that traders of
affected the restaurant sectors and even
all stripes — for better or worse — are fully
the live cattle market. In this issue, we take
using all of the tools in the options toolbox,
a deeper dive into this effect. In “How
even option writing. In “Volatility as an
big of a risk is Amazon?” (page 47),
asset class” (page 42), we discuss the
Feature Editor Garrett Baldwin discusses
evolution of managed options programs.
Binarys, Weeklys,
Volatility, ETFs & more
how companies from various sectors view
the Amazon threat. More than five dozen
companies have identified Amazon as a
threat to their business.
It is always hard to apply antitrust laws
written before the digital age to innovative
companies in newly evolving sectors. In
“Breaking up Amazon … It’s not that
simple” (page 45), Baldwin talks to Diana
Moss, president of the American Antitrust
Institute, about the chances Amazon will be
targeted for antitrust violations.
What is clear is that the Amazon has
shaken up the entire equity world and
companies not even related to the broad
retail sector are looking over their shoulders
to see if Amazon has them in its sites.
Daniel P. Collins
Modern Trader
Send your comments, criticisms and suggestions to
October 2017
M o d e r nTr a d e r. c o m
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Real talk on business, finance, politics & alternative investments.
Powered by the Daily Alpha at
“Dan Loeb dissolves
stake in Snap, but the
stock is soaring.”
That’s a headline over at Market Watch…
It’s time to fire someone.
Soaring? Snap stock was soaring on Aug. 14.
And by soaring, the stock was up 6% to close the day at a whopping $12.60.
Soaring… on the day that Snap employees were finally granted the opportunity to sell
their stock after the IPO lockout period.
Soaring… still well below its IPO level of $17 per share.
Soaring… still an incredible downturn from its 52-week high of $29.44.
We’ll beat our chest here. Back when this company went public, we advised readers to
stay far away from this company until the lockout period expired. We argued that at this
point, the markets would finally begin to determine the real value of the stock (see “Tracking stock,” page 78).
“We are not
“I am going proud of the
to go dark. result.”
Then I will
as me.”
These are the reported words of
former White House Communications
Director Anthony Scaramucci in a
conversation with Huffington Post’s
Vicky Ward on Aug. 1. The conversation
allegedly took place shortly after
Scaramucci left the White House after
only 10 days in the role.
‘If it was up to me, he would be
That’s Anthony Scaramucci ripping on
Steve Bannon on “The Late Show with
Stephen Colbert” on Aug. 14.
Well…that was fast.
October 2017
That’s John Walker, EnerVest’s cofounder and CEO.
Walker’s private equity firm isn’t — how
do we put this — good with money.
The firm was once worth more than
$2 billion; but as The Wall Street Journal
explains, the company is going to be leaving their pension, endowment and charity
clients with pennies on the dollar. EnerVest
started investing in the energy markets
with crude prices around $90 per barrel.
You know where this is going, right?
The interesting factoid here is that there
have only been seven private-equity funds
worth more than $1 billion to ever lose
client money. Losses of 25% are rare,
according to the Journal’s article. EnerVest
really outdid itself. When politicians go
after hedge fund and private equity managers; you’ll hear a lot about this fund and
what it did to pensioners’ money. This is
the extreme example, and politicians love
to make the extremes look like the center
of the bell curve.
disclosed a
$3.7 million
stake in
shares of
to a Monday
filing with
the U.S.
and Exchange
Aug. 14 delivered the markets
the latest round of 13-D filings,
and we saw a sharp uptick
in stakes of Alibaba Group
Holdings (BABA). Everyone, it
appears, is still a bit concerned
about the price of Amazon stock
and the ecommerce giant’s
So, they’re all pouring capital
into the “Amazon of China.”
This will be an interesting test.
Does the “of China” argument
work for hype? It certainly
has worked in recent weeks
for the cryptocurrency NEO,
which changed its name from
AntShares and called itself the
“Ethereum of China.”
The currency added more
than 500% in the first two
weeks of August.
M o d e r nTr a d e r. c o m
“Moore’s law specifically applied to the number of transistors
on a circuit but can be applied to any digital technology. Any
technology that is growing exponentially (i.e., ‘following Moore’s
law’) has a doubling time.”
That’s Dennis Porto, a Harvard academic and Bitcoin investor, in a conversation with Business Insider. Following the Aug. 1
“Hard Fork” of Bitcoin, prices rocketed north of $4,300 per coin.
Porto argues that the digital currency is heading to six-figures. Meanwhile, others are arguing that the cryptocurrency is in a bubble and we’ll have the opportunity to relive Tulip Mania in the near future. It’s been an incredible experience to watch. At the end
of 2015, we sat down with Tyler Winklevoss, who at the time was aiming to run the first SEC-regulated ETF for the cryptocurrency.
At the time, Winklevoss outlined one of the most intriguing theses on why Bitcoin was pushing higher. This was one of the few
generational investment opportunities of a lifetime, and those who followed his advice probably don’t need to read financial insight
ever again.
Open Outcry
Thank you for refreshing everyone’s memory, or lack thereof,
of the entire MF Global debacle and John Corzine’s central
role (August 2017). I was an MF Global account holder who
withdrew most, but not all, of my excess equity from my account
before it was stolen by John Corzine
Unfortunately, in the United States, someone can get away
with an audacious crime like Corzine’s, so long as they are wellconnected and protected politically, and wait a few years (in this
case six years) before returning to the scene of the crime.
[Modern Trader’s Editor-in-Chief] Dan Collins’ article does a
great service of setting the record straight with the actual facts
of what occurred. Some people just entering the futures arena
may have no idea what actually happened, especially when some
“journalists” prostitute themselves describing customers’ money
as having been “temporarily...missing” as described in Collins’
article. It is beyond comprehension how these writers can look
at themselves in the mirror.
For myself, my funds were eventually returned after several
years without adverse effects for myself or family. Unfortunately,
many other people were not as fortunate and could not survive
the long wait.
Since no meaningful changes with any teeth have been made
regarding the sanctity and safety of customers’ segregated
funds, and my livelihood does not depend on the futures
industry, I have permanently said good bye to any participation
in that industry. It’s hard enough to turn a profit without having
to worry that your money will be stolen by the custodians of your
Thank you once again for setting the record straight with an
accurate account of what actually occurred with MF Global.
And, [regarding the recent redesign] I like the feel of the new
paper as well as the new categorization of different topics.
W. Ennis
Nashua, N.H.
Subscriber since 1996
In Open Outcry last month I responded to a reader, R. Roach
from Tulsa, Okla., who objected to our editorial, “Face it
Paris partisans, the climate agreement was a shakedown”
(August 2017) and questioned the value of his subscription. I
concluded the response with…
We hope that you keep reading, but if your
bubble is not big enough to accommodate
articulated perspectives, which compete with your
own thinking — perhaps you pitch in to help the
environment, cancel your subscription… and save
a tree.
The response elicited more letters, including…
Regarding the letter from R. Roach and [Joseph’s]
response — keep up the good work!!!
As a trader of 43 years I think the magazine does a fine job.
There have been times that the editor/editorial section was not
to my liking, however, it gave me pause to think of my position.
And I did! This is the first time that I have written to you, and I
thank you for a great magazine. Keep up the good work.
G. Vanek
Subscriber since the ‘70s
Only one reader chose to save a tree…
After reading the [Joseph] reply to the [R. Roach] letter
in the September issue I want to be removed from your
magazine subscription. That was just ridiculous.
R. Hovanec
Bubbletown, USA*
Former subscriber*
* Publisher’s comments
Jeff Joseph
Send your comments and suggestions to
M o d e r nTr a d e r. c o m
Issue 536
We have been here through it all…
Commodities Magazine
& Financial Futures
Contracts Launched
Oil Shock
of 1973–74
Savings &
Loan Crisis
Latin American
Futures Magazine Introduced
Stock Market Crash
Asian Financial Crisis
FUTURES Magazine Introduces
Separating signal from the noise since 1972
Flash Crash;
Dodd-Frank Act
—the essential monthly journal
for professional investors &
active traders
Open Outcry Ending
Commodity & Financial Trading Floors
1848 – 2015
APRIL 2015
Hedge Fund & Private Equity News
High conviction ideas from top traders, analysts & insiders
A technical gold play
Q By Doug Busch
A cup with handle
formation is a consistent
bullish continuation pattern. Stocks that can be
bought as they pull back
into a recent cup base are
strong bullish plays. The
Franco-Nevada (FNV) gold
royalty company is a good
gold play. FNV is already
32% higher year-to-date
and sports a dividend yield
of 1.2%. Earnings are
moving in the right direction with three consecutive
positive numbers in the
last three quarters. The
stock rose firmly in early
August with active volume.
It broke above a $76.37
cup base trigger on
Aug. 10. Look to enter on
a pullback at $77.50. On
the weekly chart you can
see the buy point above a
one-year long weekly cup
base pivot of 81.26, which
would register an all-time
high if taken out.
Source: ChartSmarter
This month in TRADES
Doug Busch trades U.S.
equities using traditional
technical analysis with an
emphasis on Japanese
M o d e r nTr a d e r. c o m
Buy Franco-Nevada
New health outbreak,
new short
More upside to Amazon? 16
Do airline stocks
have room to soar?
Retail’s revenge
Amazon, crude,
gold & the big
equity short
Sugar, forex & equities
Can Amazon
keep this pace?
Amazon’s next
North Korean
tension & the return of
Issue 536
New health
new short
Q By Joseph Parnes
Chipotle Mexican Grill Inc. (CMG), the
trendy Mexican-style restaurant chain founded in 1993, develops and operates more
than 198 Chipotle Mexican Grill restaurants
in the United States, 29 international restaurants and 23 non-Chipotle style restaurants.
Denver-based CMG has become famous
for its unique food services, while also
becoming infamous for its candidacy as a
long-term short position.
Since 2015, CMG has signaled its
short-selling potential and has been continuously recommended as a short. CMG
relished its notoriety and its growth rate in
2015, sending the equity to an all-time high
of $758.61 with a market cap of $15.19
billion, an earnings per share of 16.76 and a
P/E ratio of 29.07.
In the fall of 2015 the E. Coli outbreak at
various stores in multiple locations across
CMG took out a huge support level in July.
Source: eSignal
October 2017
the United States, and the subsequent
media coverage generated by the Center
for Disease Control’s 2016 formal declaration of its direct association, led CMG
to slash its sales and earnings forecast.
This sent the stock’s price plunging from
its then 52-week high of $521.52, a market
cap of $12.82 billion, EPS of 0.77 and P/E
ratio of 525.84, as of March 8 2017. During
the same period, CMG was faced with a
secondary offering of $2.9 million shares
by a prominent shareholder activist, which
further reducing the market’s trust in CMG.
In July 2017 it was reported and confirmed that 130 customers in Sterling, Va.,
were contaminated by food from a Chipotle
restaurant and infected by the norovirus.
CMG has been unable to distance itself
from its food poisoning reputation, and
solidified its June 2017 guidance warning
that CMG’s operCHIPOTLE
ating costs would
Symbol: CMG
be higher, and that
Market Cap:
its promotional mit$9.82 billion
igation costs would
52-week high/low:
rise significantly.
Despite CMG’s mulEPS: 3.23
tifaceted attempts
P/E: 103.81
to recover from its
Short Range:
damaging and hurt$330-$349
ful press coverage
Cover Short: $199
as well as hindered
Stop loss: $361
goodwill, CMG’s
stock has continued to decline. Its
continuous disappointing earnings have
reinforced it as a volatile short position, with
more declines in the offing.
Technical picture
CMG warrants lower P/E multiples to reflect today’s slower growth rate versus its competitors.
It has plunged with a down gap since mid-October 2015 with multiple plunge milestones.
CMG soared above its 50- and 200day moving averages in late March 2017
after straddling those averages for most of
Q1, establishing a clear reverse head-and
-shoulder pattern before finally topping at
$499 on May 16. CMG then began a stark
decline, breaking below its 50- and 200day MA in June as well as its 50-week MA.
The sell-off accelerated in July following
the norovirus outbreak. CMG took out its
three-and-a-half year October 2016 low, making the next clear technical support level the
In July 2017, it
was reported
and confirmed
that 130
in Sterling,
Va., were
by food from
a Chipotle
M o d e r nTr a d e r. c o m
2012 low around $240 (see “Big level,” left).
This accelerated weakness pushed CMG
into a Death Cross on
Aug. 2, with the 50-day SMA crossing below
the 200-day SMA, while the market traded
below both. CMG last entered a Death Cross
in late November 2016 and subsequently
dropped from $576 to just below $400 in six
weeks. It entered a Golden Cross (the bullish
opposite of a Death Cross) this past March
before rebounding 25%.
CMG’s troubles are clearly not over, and
the recent fundamental weakness following
the norovirus outbreak has created extreme
technical damage.
Disclosure: The author has a short
position in CMG.
CMG entered a death cross on Aug. 2 when the 50-day SMA crossed
below the 200-day SMA while the market traded below both averages.
This last occurred in November 2015 prior to CMG dropping more than
30% during the following six weeks.
Source: eSignal
Joseph Parnes is an independent
RIA with more than 30 years of trading
experience. He specializes in short
selling. @joseph_parnes
M o d e r nTr a d e r. c o m
Issue 536
More upside to Amazon?
Yes: Amazon
is different
Q By Joseph Parnes
Retail online giant Amazon Inc. has been
the focus of intense investor speculation
due to its pending acquisition of Whole
Foods (WFM). However, those who have
marked Amazon (AMZN) for a short
position are being short-sighted and
undoubtedly fail to see the opportunity to
accumulate a position for solid long-term
growth. Amazon’s downward momentum
is not fundamentally sustainable, and its
upward movements will be generated by
high volatility within bid-ask prices resulting
in a short squeeze.
AMZN, currently boasting a stock
capitalization of nearly $500 billion, was
founded in 1994 and is headquartered in
Seattle. The company engages in the retail
sale of consumer products and service
subscriptions in North America and internationally. From its humble inception focusing
expressly on books, AMZN has expanded
into unanticipated retail segments such as
artificial intelligence, food, music, media
content, publishing, manufacturing electronic devices and consumer products.
AMZN’s June 2017 quarterly report
indicated a 25% increase in its revenue to
$38 billion while its operating income slid
51% to $628 million (adjusting for periods
of earning expansion with increased investing). AMZN’s recorded capital investment
comprised of its yearly capital expenditure
of $2.5 billion (up 46%) and its capital
leases such as property and equipment —
up 50% to $2.7 billion — has astonished
the street. These numbers are indicative of
AMZN’s demonstrative efforts to reinvest
and refine its shipping capacity, digital
video segment, Echo device and affordable
cloud services solutions.
Those who hold onto traditional methodologies and try applying them to AMZN
fail to understand that AMZN has never
followed a traditional business model. They
are expecting corrections and retractions
similar to other stocks, rather than embracing AMZN’s 20-year proven model as
sufficient evidence that AMZN is different
and has a unique growth metric. AMZN’s
surprising acquisition of Whole Foods only
serves to provide further support that the
company has not topped off, and will continue with its forward momentum.
This all has implications that will boost
AMZN’s bottom line. Even in the face of a
potential failure to acquire Whole Foods
and expand its physical offerings, Amazon has proven itself capable of handling
defeat, as it has with other failed expansion attempts (i.e., AMZN’s Fire phone).
AMZN’s window for investors to purchase
will eventually shut as AMZN continues to
Those who hold onto traditional
methodologies, applying them to
Amazon, fail to understand that it
has never followed a traditional
business model.
October 2017
evolve and reshape the future for both its
shareholders and the world. Hence, keeping AMZN in your portfolio as a long-term
growth solution is a smart and lucrative
future investment.
AMZN has broken the traditional valuation model since 1995 from its sporadic
profitable quarters versus the belief of sacrificing profitability for growth. Its technical
outlook indicates a status of reinforcement
rather than divestment due to its P/E ratio
dropping to low triple digits from a commanding high triple digits and has been on
a clear pattern of ascension since 2016.
Continually trading above its 50- and
200-day moving average, AMZN has been
a picture of consistency leading to its rise
through early June when its price temporarily breached $1,000. A sell-off has held
above its July low near $950.
Sporadic correction and retraction
operating above 50-day MA may challenge
support below this level, perhaps testing
$910. Shorts in general are difficult to master because of the scarcity of float/liquidity,
requiring a contrarian sense of objectivity
and Amazon’s business model is equally
contrarian by its nature. In the context of
the market, AMZN is most solidly a long
position and provides a unique opportunity
for any portfolio accumulation. AMZN may
not have reached the low of this correction,
but there is more room on the upside.
We recommend buying AMZN between
$970 and $988 with a near-term objective of $1,108. Longer-term, we think that
AMZN can reach $1,250. A drop below
$903 would indicate further weakness, but
AMZN will be back above the $1,000 mark
relatively shortly.
Disclosure: The author has a long
position in Amazon.
Joseph Parnes is an independent
RIA with more than 30 years of trading
experience. He specializes in short
selling. @joseph_parnes
M o d e r nTr a d e r. c o m
No: Amazon’s
earnings tell
Q By Bill Gunderson
My first investment in Amazon
(AMZN) was initiated on Feb. 5, 2015. At
the time, the stock was trading at $377.72
per share. We finally started seeing
those skinny margins begin to add up to
some meaningful earnings and earnings
If there is one thing that you pick up after
two decades of following research reports
as a professional money manager, it is that
stocks and indexes follow earnings.
It’s pretty simple. When earnings are
going up, the index and stocks follow right
along, unless of course the index gets too
As long as the earnings continue to grow,
the stock follows right along. Facebook
(FB), Netflix (NFLX) and Amazon (AMZN)
are good recent examples of that.
When earnings growth begins to slow,
so does the stock price appreciation.
Stocks like Coca-Cola (KO), Cisco
(CSCO) and Intel (INTC) are good
examples of that.
When earnings begin to decline, look out
because the stock will follow right along.
IBM, General Electric (GE) and Exxon
(XOM) are good recent examples.
This is why
quarterly and annual
earnings reports
Symbol: AMZN
are watched so
52-week high/low:
closely. They are
the best evidence
Market cap:
$472.77 billion
and indicators
EPS: 5.31
of the trajectory
P/E: 185.47
of earnings and
future expectations. If a company misses
expectations and guides lower, the stock
immediately adjusts lower. Conversely, if
a company exceeds estimates, the stock
will almost always break out to new recent
highs. We saw this with Boeing (BA) and
Caterpillar (CAT) in late July.
My initial long on Amazon in early
February of 2015 followed expectations its
earnings were finally starting to ramp up.
After losing 52¢ per share in 2014,
expectations were for Amazon to turn
profitable in 2015, which it did. Amazon
ended up making $1.25 per share in 2015
after that 2014 loss.
But the real number that caught my eye
was its 2016 expected earnings growth of
more than 300%. AMZN exceeded that,
reporting annual earnings of $4.90 per
share in 2016, nearly 4X its 2015 earnings.
By late October of 2016, my position
in Amazon was up 105%, and we were
headed into the last few weeks of a hotly
contested presidential election. Amazon
had become a bit pricey at that point, so I
took profits on Nov. 2, 2016, at $776 per
share, a gain of 105%. Initially, this turned
out to be a good move as the election did
not go as expected and the tech stocks
suddenly took a back seat to the banks and
AMZN made multi-month lows in midNovember and earnings expectations
began to ramp up once again. I got back in
on Jan. 12 at $804.86 per share.
The stock has been one of the biggest
winners in the market in 2017. That Jan. 12
When earnings growth
begins to slow, so does the stock
price appreciation.
M o d e r nTr a d e r. c o m
position was up more than 25% by June
and earnings expectations continued to go
higher as Amazon took on one business
after another.
By June 19, 2017, Amazon’s shares were
up 50,293% since its 1997 debut. Amazon
chief Jeff Bezos had become the second
richest man in the world and would soon
pass Bill Gates at #1. He actually did pass
Bill Gates briefly in July on the morning
Amazon hit new all-time highs.
But then, something happened later that
morning before the company was to report
after the close. The stock and the Nasdaq
began turning around and selling off quite
aggressively. Amazon earnings fell far short
of expectations after the market closed. It is
hard for me to believe that some big players
did not know that Amazon was going to
whiff big time on its after-hours report.
Nothing else would explain that sudden
mid-day turnaround.
Amazon’s Q2 earnings report was one
of the biggest whiffs in a long time. I exited
the long the following week.
On June 19, AMZN was expected to earn
$12.43 per share and continue to grow
by 29% per year over the next five years.
My five-year target was $1,635. Following
Amazon’s disappointing report, the
consensus earnings estimate for 2018 have
plunged from $12.43 per share to $8.76
per share. This 29.5% drop in expectations
is one of the quickest and most stunning
turnarounds in the expectations for a stock.
It is bit strange to see that the stock
is only down 6.2%, while earnings
expectations have plunged by 29.5%. It
may have further to fall before earnings
expectations rebound.
Just when a company and its CEO seem
invincible, you realize that the company is
going through some severe growing pains.
It’s time to look elsewhere while Amazon
sorts some things out.
Disclosure: The author has no positions
in any of the stocks mentioned.
Bill Gunderson is a wealth manager and
president of San Diego-based Gunderson
Capital Management, and the creator of
the Best Stocks Now app.
Issue 536
Do airline stocks
have room to soar?
Q By John Blank
Summer is the time Americans look to
travel to their favorite vacation spots, whether to a lake, a beach or the mountains;
and this year folks appear ready to go. The
Airline Transportation industry in July was
ranked by Zacks Industry Rank System at
#13 out of 265 industries. That puts this
25-company strong group in the top 5%.
Year-to-date returns have been 19.8%,
nearly doubling the 10.8% return of the
S&P 500. This indicates a nice share price
outperformance. Can it continue?
Putting a share price bottom in July 2016,
airline stocks soared in the second half of
2016 and first half of 2017, led by two of the
three biggest players: American Airlines
(AAL) and United Continental (UAL).
Global commercial airlines made record
net profits in 2016 of about $35 billion,
according to the International Air Travel Association (IATA). That’s way up from nearly
$14 billion in 2014, and about the same as
in 2015. North American commercial airlines felt the upswing the most, representing about $20 billion of that 2016 profit.
However, for 2017, forthcoming IATA
travel revenue data may be lower. Airlines
shoulder a lot of significant risks, particularly macro factors such as sudden shifts in
personal disposable income and spending
patterns, safety concerns over terrorist attacks, oil price shocks and analyst
sentiment. All of these can turn quickly and
weigh on airline profits.
In addition, the United States’ welcome
mats have been selectively removed from
our airports. The world’s tourists (more
broadly) have taken notice.
Prior to March 2017—the time of the
second Presidential executive order travel
ban—New York had forecast an increase of
400,000 foreign visitors to the city in 2017.
Forecasts made after the travel bans predicted a decline of 300,000 foreign visitors
to New York in 2017.
Let’s see what actually happens. The
October 2017
Top stocks in top rated industries
Source: Zacks
Semiconductor Equipment-Wafer Fab
Retail- Consumer Electronics
Soap and Cleaning Materials
Glass Products
Manufacturing-Farm Equipment
Food-Meat Products
Manufacturing-Material Handling
Top Stocks
Top rates airline stocks by Zacks.
Source: eSignal
U.S. Supreme Court allowed parts of the
travel ban to stand and will hear arguments
and write its opinion on the travel ban later
this year or early next year.
As to longer-term risk management, look
for order deferrals on large aircraft. This is an
indicator of how airlines view future demand.
The top Zacks #1 Rank (strong buy)
airline picks are: Air France (AFLYY),
American (AAL), Delta (DAL) and Southwest (LUV).
Why these four? Share price momentum
is clearly on (see “Best in flight,” above).
The long-term Zacks value, growth and
momentum (VGM) score is “A” in all four
cases. There is more future growth to chase
at a reasonable current stock price.
John Blank is the chief equity strategist at Zacks. He covers the global
financial markets for @
M o d e r nTr a d e r. c o m
Q By Matt Litchfield
Americans love stories about self-made
men who built their business empires on
sweat and ingenuity. Titans like Andrew
Carnegie, Henry Ford, Warren Buffet
and Bill Gates, and now it seems Jeff
Bezos has joined their ranks. Nothing
has captivated investors like Amazon’s
(AMZN) share price cresting at $1,000,
generating annualized returns close to
29% during the last decade and briefly
making Bezos the richest man in the world
in the process. Small wonder that so
many are willing to overlook that Amazon
only recently became profitable, thanks
to cloud computing, not retail. And even
then, its profit margin is so thin that buying
a supermarket chain—the epitome of a
low-margin business—like Whole Foods
(WFM) will actually drag it higher.
However, we’re not here to talk whether
Amazon is still a good investment, but
to point out that in a market addicted
to stories, the company’s phenomenal
growth has reached a point so extreme
that exchange-traded fund heavyweight
ProShare Advisors has filed paperwork
with the Securities and Exchange
Commission to create several new funds
that are long online/short brick and mortar
retailers in both an unlevered and 2x or
3x levered format to help investors reap
more profits from the industry’s inevitable
passing. But while most are blinded by
Amazon’s success, a few remember that
the best time to buy is often when there’s
blood in the street and there’s no bloodier
part of the market right now than retail.
A year ago, we talked about looking for
overlooked bargains and coming up with
nothing but depressed retailers, not much
has changed (see “Amazon, arbitrage &
M o d e r nTr a d e r. c o m
retail ETFs,” Modern Trader, August 2016).
Even the biggest brick-and-mortar retailers
like Wal-Mart (WMT) and Home Depot
(HD) are lucky if their stock prices are positive and only trailing Amazon’s by less than
20% compared to the previous year. But
that relative lack of performance has only
helped to make retailers relatively more attractive, and even as Amazon geared up for
its last big push to $1,000, the largest dedicated retail ETF (the SPDR S&P Retail ETF
(XRT)) found a double bottom and it wasn’t
thanks to its 1.1% allocation to Amazon.
We mentioned in that article that XRT is
an equally-weighted fund where the close
to 100 holdings start with same weight in
the portfolio after each rebalancing, which
means more volatile small-cap stocks play
a much larger role in the portfolio than
in market-cap weighted funds like the
Consumer Discretionary Select Sector
SPDR Fund (XLY) or the VanEck Vectors
Retail ETF (RTH) where bigger names
rule the roost; with 16% and 20% of their
respective portfolios invested in Amazon.
Those large allocations to Amazon meant
healthy returns to both funds in the 12-month
period ending in July, although neither could
keep up with the broader S&P 500.
Until now, XRT’s broad base of retail
stocks might have offered investors
exposure to the wrong side of the retail
trade, but that long list of names could
mean the recent double-bottom is signaling
the sector is starting to heal. If that is the
case, market-cap weighted funds like XLY
and RTH with large positions in Amazon
could find themselves between a rock and
a hard place if investors begin to shift from
Amazon to more value-oriented names
(see “ETF reversal?”). If that does come to
pass, RTH could potentially suffer a double
whammy from its concentrated portfolio.
With just 26 of the largest names, any rally
that involves smaller retailers or specific
subsectors could leave investors missing
the potential upside while simultaneously
being exposed to profit taking in an
overextended Amazon.
Matt Litchfield is the content editor for
ETF Global at @ETF_Global
If Amazon corrects and challenges smaller retailers rebound, the
equal weighted XRT will likely outperform market cap weighted
indexes like the RTH.
Source: eSignal
Issue 536
Amazon, crude, gold
& the big equity short
Q By John Rawlins
The Cycle Projection Oscillator (CPO) is a technical tool that employs
proprietary statistical techniques and complex algorithms to filter
multiple cycles from historical data, combines them to obtain
cyclical information from price data and then gives a graphical
representation of their productive behavior. Other proprietary
frequency domain techniques then are employed to obtain the cycles
embedded in the price.
Amazon (AMZN) has been a top performer for several years, but
the CPO did not capture the correction from its later July high. In
fact, the sell-off has put AMZN close to oversold territory in the CPO
as it anticipates the market to grind higher into December. This is
a good buying opportunity. However, the CPO anticipates Amazon
making a significant top at the end of 2017, which should set up an
opportunity to short.
Crude oil: After some volatile swings, crude oil has seemed to settle
into a range in August. Don’t expect that to last. The CPO is indicating
that the early August halting rally should top off around $50 and for
crude to head lower into October, though it probably won’t take out the
summer lows around $42 per barrel. Any fall sell-off should be seen as
a buying opportunity as the CPO expects crude to rally sharply in Q4,
challenging the 2017 high. That rally is expected to peter out by yearend and set the stage for a massive sell-off in Q1 of 2018.
Gold started 2017 off with a massive rally that has been followed by
three large swings moving the shiny metal between $1,200 per ounce
and $1,300 per ounce for most of 2017. The CPO is expecting gold to
settle down in a range for the rest of 2017. The CPO indicates that the
current short-term rally in gold has a little upside left before it will turn
lower in the fall. However, it does not anticipate a major move, so any
push to either end of gold’s 2017 range would be an opportunity for a
range trade.
S&P 500 (SPX): The CPO has been anticipating a major move
lower in all of the stock indexes this summer, but each time this
appears to be in the works, equities rebound to new highs. The most
recent strength has moved the SPX into overbought territory in the
CPO just as it is indicating a sharp move lower. Could the longanticipated sell-off be on the way? The CPO thinks so, and it could be
huge, challenging the November 2016 election lows.
John Rawlins is a former member of the CBOT with more than
30 years of experience in trading and research. He co-developed the
Cycle Projection Oscillator with an aerospace engineer. @cpopro1
October 2017
M o d e r nTr a d e r. c o m
A look at long-term trends of commercial interest in the
CFTC’s “Commitments of Traders” report.
4 Week Net
Change +/-
Reversal -
Reversal +
Reversal -
Reversal -
Reversal -
Trend -
Trend -
Trend -
Trend -
Trend -
Reversal Sideways
Reversal +
Reversal -
Trend +
Trend +
Trend +
Trend +
Reversal -
Reversal -
Reversal -
M o d e r nTr a d e r. c o m
Sugar, forex
& equities
Q By Andy Waldock
Commercial traders in sugar futures have set another net long
record position. The October futures contract has successfully
defended the low mentioned last month, and the commercial traders
appear to be forcing the weaker speculative positions out of the market. There is a growing disparity between the Indian sugar market
supplies as reported by mainstream news versus what appears to be
popping up on smaller grassroots sites. Many agencies have been
calling for an increase because last year’s El Niño hindered production by at least 15%. However, the commercial sugar refiners don’t
seem to trust what they’re hearing. The record-setting purchases by
the sugar mills along with a widening spread between the October
2017 and March 2018 sugar contracts are both indications of nearterm tightness. We expect the October sugar futures to continue to
rally through the last trading day (Sept. 29).
Currencies: The currency markets have finally had some directional movement and are testing multi-year levels. Thus far, we’ve seen
standard actions by the commercial traders who are scaling into
their trades on a counter-trend basis.
The U.S. Dollar Index is threatening its 2016 low near 91.50. Commercial traders maintained a net short position greater than 50,000
contracts the entire time the Dollar Index was trading above 100.
However, net commercial purchases since mid-June are threatening
to push the commercial trader net position into positive territory for
the first time since early 2014. We expect commercial buying to
show up at the lows, but their mid-range total position size indicates
they are not ready to commit to a dollar bottom, yet.
The euro is testing its August 2015 high around $1.20 and is
clearly being pushed by speculators as they are long 1.85 contracts
for every contract they’re short. This is the most bullish speculative
COT ratio since November 2013. This is an overbought indication.
Commercial short-selling could quickly force speculative losses on a
decline to near-term support around $1.12.
Stocks vs. bonds: Money flowing into the stock market equals
“risk on.” Money moving from the stock market to the long side of
the bond market equals “risk off.” Based on the action, we’re seeing
in the COT report, we want to do two things. First, we don’t think
bonds will attain the new high we mentioned previously. However, we do still expect to be able to sell them above June’s high. A
pullback in the stock market, specifically the December Dow Jones
futures, is inevitable. Speculators are long the Dow futures at an
eight-to-one ratio. Speculators being washed out of their Dow
positions are likely to funnel money into interest rate futures. The
commercial traders are typically one step ahead of the speculators.
Therefore, expect commercial traders to initiate short interest rate
positions on a speculative flight to quality.
Andy Waldock is a futures trader, analyst and founder of the
brokerage firm Commodity & Derivatives Advisors. @waldocktrades
Issue 536
Can Amazon
keep this pace?
Q By Dan Keegan
On July 5, 1994, Jeff Bezos founded Inc. It was based in Seattle
but its reach was worldwide. It started
out as an online bookseller and eventually
Amazon drove Borders Books into
bankruptcy. It was a short life for Borders,
which was portrayed as an evil predator
to mom and pop bookstores, but Amazon
would grow to become the real Death Star
to brick and mortar retail stores. Amazon
now sells just about everything online
and it is even looking to deliver most of its
products via drones.
On May 5, 1997 Amazon (AMZN) went
public at $18 per share. A year later it split
2X1, and would split twice more, 3X1 in
January 1999 and 2X1 in September of that
same year. AMZN stock has not split since
and this summer it has breached $1,000.
Split adjusted, AMZN’s IPO price was $1.50.
If you had invested $10,000 on the IPO date
your investment would currently be worth
$6,666,666.67 (see “Amazon explosion”).
Jeff Bezos is battling fellow Seattle
resident, Bill Gates, for the title of world’s
richest person. In 2015 AMZN surpassed
Wal-Mart (WMT) as the world’s biggest
retailer. The current P/E for WMT is
18.4. The current P/E for AMZN is an
astounding 186! If WMT had the same P/E
as AMZN, it would be trading at $810. The
market obviously believes that AMZN will
grow much faster than Walmart, and that it
will eventually dwarf Apple (AAPL), which
also has a P/E of 18.4. Therein lies the
rub. The trend is your friend and the trend
is definitely pointing upwards, but the P/E
seems ridiculous.
The trend is definitely
pointing upwards, but the P/E
seems ridiculous.
Amazon stock has grown 700X since its 1997 IPO.
Source: eSignal
October 2017
The first thing you need to do when
looking at establishing an options position
is to look at is the skew. If the demand
for out-of-the-money puts is greater than
equidistant out-of-the-money calls, then
it is positively skewed to the downside
and negatively skewed to the upside. That
is the way that options on most equities
trade. The SPDR S&P 500 exchangetraded fund (SPY) August 240 puts have
an implied volatility of 11.28%, and the
SPY August 255 calls have an implied
volatility of 6.57%. SPY moves down
much faster than it moves up, according
to the skew. The AMZN September 935
puts have an implied volatility of 22.74%
while the September 1065 calls have an
implied volatility of 21.74%. It is a normal
distribution as opposed to the asymmetric
distribution in SPY. Ratio spreads are
therefore out of the question.
Here are two options scenarios to
play on Amazon. Four weeks before the
Sept. 1 weekly expiration AMZN closed
at $988.90. The 1010 calls are trading
at 12.10 and the 1015 calls are trading at
10.40. Going long five 1010-1015 vertical
spreads at 1.70 would cost $850. That
would be your max loss at $1,010 or
lower on expiration. It currently gives you
an equivalent share position of 25 long
shares. Your max profit would be $1,650
at 1015 or higher at expiration. The 1020
calls are trading at 9.20. You can reduce
your cost by selling the 1020-1015 call
vertical at 1.20. You have a max profit
of 1.20 ($600) at 1015 or lower and a
max loss of 3.80 ($1,900) at 1020 or
higher. The max profit, if you combine the
two spreads, would be $2,250 at 1015,
where the max value for both spreads
begins. The most that you could lose
would be $250 when AMZN trades below
$1,010 or above $1,020 (see “Hitting
the middle,” right). Before expiration as
AMZN approaches $1,015 the spread
would increase in value. It would be a
marginal increase, expanding most during
expiration week.
On the downside, you could buy five
Sept. 22 weekly 960 puts at 18.10 and sell
five Sept. 1 weekly 960 puts at 10.60 for
a cost of $3,750. That is your max loss on
the trade. The equivalent share position
M o d e r nTr a d e r. c o m
for this spread is short 25 shares. There
is no exact profit for a time value spread
like there is for a vertical spread. When the
short side is expiring, you don’t know what
the demand will be for the long side that
has three weeks left. Currently the
Sept. 1 put has an implied volatility of
20.76%, while the Sept. 22 put is at
21.40%. The ideal spot at expiration
is $960 since your short goes out
worthless as your long gains in value as it
approaches $960.
When AMZN moves in either direction
adjustments should be made. When it moves
up you could sell of your long puts and buy a
cheaper put nearer to expiration. You could
sell put vertical as well. Dynamic hedging
gives you the greatest odds of success.
By executing a bullish vertical call spread, you ensure a significant profit with
defined risk. If you are confident Amazon will trade up to the $1,015 range, you can
improve profit potential and reduce overall risk by also executing the short 10201015 call spread, though you would need Amazon to settle within the $1,010 to
$1,020 range.
Source: eSignal
Dan Keegan is an options instructor and
founder of
Q By Joe Cornell
Source: Spin-Off Research
M o d e r nTr a d e r. c o m
You can beat the Street. At a time when
many professional investors lament that
the proliferation of exchange-traded funds
(ETFs) and widespread use of screening
techniques have made it harder to find
bargains in the stock market, one simple
investing approach continues to outperform: spin-offs.
Spin-offs have long been a fruitful investment area; a number of academic studies
show that they historically have generated
far better returns than the overall stock market. A spin-off occurs when a corporation
issues stock in a subsidiary to its shareholders to create a new public company. A
related corporate event is an IPO carve-out,
through which a company sells the public
a stake in a unit, while retaining the rest of
the division. Sometimes, the remainder is
later distributed to shareholders.
The Bloomberg U.S. Spin-Off Index has
surged 18.9% in the first seven months of
2017. The S&P 500 Index has increased
11.6% in that same period (see “Beating the benchmark,” left). The spin index
Issue 536
Last year,
there were
35 total spinoffs, with a
total market
value of $100
generated a total return of 182% in the
past five years (versus 99% for the S&P
500). The Bloomberg US Spin-Off Index
has produced a total return of 867% since
its Dec. 31, 2002 inception. The S&P 500
generated a total return of 278.5% over the
same time frame.
Why do spin-offs outstrip the market?
Spin-offs benefit from greater management
focus and accountability as stand-alone
The Bloomberg Spin-Off Index has outperformed the broad markets over the last
Spin-Off Research
Total Return
5-year return
10-year return
Spin-Off Index
18.90 %
246.20 %
S&P 500
public companies versus when they were
part of larger enterprises. The rational for
spin-offs varies. Some companies wish
to get rid of a weak or low-margin division
that is detracting attention from the parent.
Other companies seek to highlight the attributes of a desirable unit whose full value
may not be reflected in the parent’s stock
price. There also is pressure on management from the growing number of activist
investors, whose prescription for a lagging
stock often is a breakup. Last year, there
were 35 total spin-offs, with a total market
value of $100 billion (see “2016 Spin-Off
form,” below).
Joe Cornell is the founder and publisher of Spin-Off Research, a Chartered
Financial Analyst and author of Spin-Off
to Pay-Off. @spinoffresearch
Completed 2016 spin-offs
Source: Spin-Off Research
Completed Spin-Offs YTD
Spin-Off Date
Hilton Worldwide
Hilton Grand
Hilton Worldwide
Park Hotels &
Varian Medical
Varex Imaging
Hewlett-Packard Enterprises
DXC Technology
Hess Midstream Partners
SEACOR Holdings
SEACOR Marine Holdings
Societe Generale SA
Ionis Pharmaceuticals
Vornado Realty
Venator Materials
CO = Something ?
October 2017
M o d e r nTr a d e r. c o m
Q By Christine Short
This spring Amazon (AMZN) celebrated its 20th anniversary as a publicly
traded company. In that time, the Internet
retailer has continually grown, now with
the fourth highest market capitalization of
all public companies at $487 billion. Only
Apple (AAPL), Alphabet (GOOGL) and
Microsoft (MSFT) come in higher. What
started as a business looking to disrupt the
bookstore industry has disrupted multiple
additional sectors with their own inefficiency
The Amazon everyone knows best is
the online retailer. The core e-commerce
business continues to grow thanks to the
strength of Amazon Prime. Amazon’s ecosystem includes exclusive products, such as
Amazon’s Kindle and Echo, which require
access to Prime. During the past year,
Amazon Prime memberships have nearly
doubled, now estimated at 80 million with
AWS has shown solid growth over
10 quarters.
Source: Amazon
M o d e r nTr a d e r. c o m
almost half of all U.S. adults having Prime
In fact, the company’s third annual Prime
Day, held in July, was the largest ever global
shopping event for Amazon, selling more
than 40 million items. More individuals
signed up for Prime than any other day in
the company’s history.
Given Amazon’s dominant market share,
the company still maintains modest margins
from its global scale and footprint. Amazon’s
focus on superior customer service helps
drive higher purchase frequencies, larger
order sizes and an overall better customer
But Amazon isn’t just about retail anymore. Amazon Web Services (AWS)
is one of the company’s most profitable
divisions and is often thought of as a key
engine of growth. AWS currently leads the
cloud infrastructure industry, representing
about 30% of the market. The
company has seen AWS revenues grow by double digits yearover-year for the last 10 quarters
(see “AWS growth path,” left).
In recent years, large enterprises such as Netflix (NFLX)
have migrated to AWS to be
its platform provider, which
validates its credibility and
reliability. In addition, this year
Amazon has begun expanding
its web services in five new
regions, including China, India
and the UK. Heavy investments in global expansion on
top of Google (GOOG) and
Microsoft’s ascension in cloud
computing will put pressure on
Amazon’s margins. On the bright side, the
expected growth in cloud computing and
the Internet of Things should support an
optimistic outlook as Amazon continues to
expand its web services.
The latest industry Jeff Bezos has decided
to take on is grocery stores. Amazon is trying
to disrupt this space using a two-pronged
method that invests in both online grocery
delivery and brick and mortar locations. Amazon Fresh rolled out its invitation-only beta
test grocery delivery service in the Seattle
area in 2007, and currently owns a very small
slice of the online food delivery market. In
aggregate, online grocery orders account
for 2% of all grocery shopping. The main
reason for this is that many consumers want
the ability to pick out their own produce and
proteins, and Amazon realizes that there will
always be a market for these people.
As such, they began experimenting with
Amazon Go earlier in the year in Seattle,
a brick and mortar model that charges
customers for the products they buy through
an app on their phone, reducing the need
to wait in a checkout line. The company
made further moves into the physical grocer
space in June when they purchased Whole
Foods (WFM) for $13.7 billion. While it
may seem like an odd choice for a retailer
known for value pricing to buy a high-end
grocer, it’s their customer loyalty and favorable employee policies that make them a
desirable purchase. Also, with 450 stores,
Amazon can get closer to their customer.
There are endless debates on which,
if any, retailers can catch up to Amazon.
Typically Wal-Mart (WMT) is the only name
mentioned with any confidence. Not only
does it have the capital to even the playing field, but it also has the real-estate to
establish the necessary warehouses. Their
purchase of in 2016, and of Bonobos on the same day of the Whole Foods
acquisition, shows just how serious they
are to reestablish themselves as the world’s
largest retailer, and could potentially be a
concern for Amazon going forward.
Christine Short, Estimize senior VP,
is an expert in corporate earnings who
produces content highlighting Estimize
data. @Estimize
Issue 536
North Korean
tension & the
return of
Q By Abe Cofnas
Currency trading in the coming months
will require more attention to fundamental
and sentiment analysis than usual. Rising
tensions relating to North Korea’s nuclear
capability are generating special challenges
to currency traders. Currency price direction
that commonly reflects economic expectations relating to monetary policy and interest
rate differentials is being punctuated by
sudden unexpected comments by President
Trump and responses from North Korean
leader Kim Jong-un. This war of words can
distort price patterns. For example, bullish
sentiment in the U.S. dollar grew on Aug. 4
due to a better than expected jobs report.
However, bullish persistence was thwarted
by increased geopolitical tension due to the
North Korean situation, and in particular, following Trump’s “fire and fury” remarks of Aug.
8. The bearish reaction in the U.S. dollar/
Japanese yen (USD/JPY) currency pair and
related pairs are leading indicators of what
the future may hold for currency traders.
Currency strategies based on reliable
technical patterns and long-term fundamentals are being trumped by a return to riskon/risk off trading and safe-haven flows: the
VIX increases, the yen and CHF get stronger and gold surges. They follow principles
of crowd behavior. The initial reaction to an
aggressive Trump tweet or a North Korean
missile test or threat is to take capital out of
harm’s way.
These currency pairs likely will be
sensitive to North Korean tensions.
The challenge ahead is how to monitor
and trade through these turbulent forex
waves. A first step is to establish safe-haven patterns. A good idea is to have the
Japanese yen (USD/JPY), gold (XAU/
USD) and Swiss Franc (USD/CHF) on your
screen. If geopolitical news comes out, the
five-minute pattern provides an early signal
of the strength and seriousness of the
reaction. This concept reflects the principle
that a currency pair will remain in a pattern
until news breaks it out of its pattern. A key
metric for measuring the strength of the
move is whether the pair involved is able to
engender a sequence of new high or new
low closes. The forex sector often is the first
to read and react to geopolitical news.
A second clue to provide insight into how
the currency market is responding to North
The initial reaction to a North
Korean missile test or threat is
to take capital out of harm’s way.
October 2017
Korean tensions is realized by monitoring
the CHF cross pairs. The Swiss franc gains
strength during geopolitical tension. Knowing this, the CHF pairs should be generally
bearish, and one of the best crosspairs to
be watched is the euro/Swiss franc (EUR/
CHF) pair. Because the euro has been
relatively strong due to economic conditions,
how the euro reacts in the context of a North
Korean crisis will be particularly revealing.
Money will tend to flow out of the euro into
the CHF. A strong euro will be no match for
the strengthening CHF in the case of a riskon/risk-off market. This crosspair will provide
a quick confirmation of whether the tensions
are cascading throughout the currency
markets. It will also provide confirmation of
stress relaxation as tensions recede and the
EUR/CHF returns to a bullish pattern.
A third approach to trading the next
North Korea provocation would be to find a
currency pair that magnifies the move. The
British pound/Japanese yen is such a pair.
The pound has been bearish, independent
of a rise in geopolitical tensions. This is
mainly due to Brexit uncertainties coupled
with a decline in consumer confidence and
negative real wage growth. The pound will
be particularly vulnerable to a safe-haven
move into the yen and GBP/JPY will likely
lose more than other yen crosspairs.
Trading through tensions in North Korea
and other geopolitical hotspots requires
good timing skills and diligence. Nervous
markets produce sharper spikes. Stops and
resting orders can be dangerous as can
holding positions overnight. Monitoring a set
of underlying instruments (USD/JPY, XAU/
USD, EUR/CHF, GBP/JPY) will provide
real-time clues to how global markets are
reacting. An actual outbreak of hostilities
will completely change the trading environment and present huge obstacles to trading.
Margin requirements will certainty increase.
Stops will be taken out with a great deal of
slippage. The USD/JPY may strengthen by
1,000 pips. Central banks may coordinate
intervention to stabilize the currencies. The
best approach to trading in such a scenario
would be to stand aside and let price action
confirm a relaxation of tensions.
Abe Cofnas is a fundamental forex
trader and coach. @abecofnas
M o d e r nTr a d e r. c o m
Options on ETFs
& ETFs on options
PUT a cap on
Weekly options:
A more
precise tool
Options products are constantly evolving. When listed
options were first launched only calls existed and you
could only buy them. The creation of additional products
and strategies marches on, from weekly options to
index options. Here, we look at the nexus of option and
exchange-traded fund innovation to share the newest risk
management tools.
We also dig deep into the world of binary options — a
backwater consisting of unseemly players just a few years
ago, it now appears to have come of age with additional
markets to trade and competitive players.
Binary options
are here to stay
Volatility as an
asset class
Finally, we go over the history of the use of options
in managed programs. It tells the story of how volatility
trading has moved from a niche strategy to a legitimate
asset class. There appears to be renaissance, by both
professional and retail traders, in option writing strategies.
This could be a problem once volatility returns to more
normal levels.
M o d e r nTr a d e r. c o m
Issue 536
Options on ETFs are growing, and so are
ETFs that offer exposure to options strategies.
Options on ETFs
& ETFs on options
Q By Daniel P. Collins
There is a growing demand for options on exchangetraded funds (ETFs) as well as ETFs that deliver optionsbased strategies. It is the result of the endless pursuit of yield in a
period of shrinking volatility along with the long-term trend toward
passive investment strategies.
On the latter, it may be fair to point out that movement toward
greater investment in passive strategies may be more the product of
financial innovation within that space than the more traditional — and
frankly tired — debate between passive and active investing. We
will delve into that later, but it will be good to remember why ETFs
were first created, which was to make investing in certain financial
products, strategies and asset classes easier for the retail investor.
The first ETF created was on Standard & Poor’s depositary
receipt (SPDR) and it allowed investors to gain access to the
S&P 500. Before that, a trader would have had to trade S&P 500
futures, which was something restricted from most registered
investment advisors (RIA) and thought to be too risky for the
Options on ETFs have grown steadily during the last decade.
Source: The OCC
October 2017
average retail trader; or a trader would have to try to replicate the
entire 500-member index with individual stocks.
“The ETF market has grown in leaps and bounds over the last
few years because there has been a seismic shift from active
management strategies to passive strategies,” says Bill Looney,
CBOE Global Client Services, Head of New York (see “ETF options
growth,” below). “In 2016 something like $800 billion in assets
moved into ETFs — about $500 billion of which where new money
flows and $300 billion were out of mutual funds and into ETFs.”
The main factor for that growth is lower fees, which is not
surprising. What is surprising perhaps is that it has led to growth
in options trading. “A lot of growth in options volume [is] a
direct result of that money flow into the underlying ETFs, where
customers will seek to hedge, speculate or yield enhance through
the use of those options,” Looney says.
He attributes a lot of the options volume growth to premium
selling due to the advent of weekly and shorter-term duration
options. “Retail customers, RIAs [and] institutional
customers seek to sell short-term premium because
the yield capture from selling that volatility has proven
to be extremely profitable over the last couple of
years,” Looney says. “It creates higher risk-adjusted
return, higher Sharp Ratios and overall the market has
had no significant volatility even where a majority of
people have gotten hurt trading those strategies in any
meaningful capacity.”
He has also seen an increase in traders selling puts.
“This strategy has grown back to be in vogue with the
retail and institutional community. It has been quite some
time since we’ve seen this strategy being used by such a
broad array of market participants. It is a very compelling
strategy and it is a very compelling yield,” Looney says.
In recent years, volume has concentrated in a few
names; more than 50% of overall options volume occurs
in 15 names, of those 15 names, ETF options like
SPDRS, IWM, QQQ and EEM are included.
M o d e r nTr a d e r. c o m
A lot of growth in options
volume [is] a direct result
of that money flow into the
underlying ETFs.
--Bill Looney
ETFs on options?
The logic behind PUT is that the ETF sells an at-the-money put
and receives a premium. If SPX settles above the put it is out-ofthe-money and collects the premium. If SPX falls, you lose the value
of the retracement minus the premium it collected. It will reduce
losses in a down market, earn money in a flat market and restrict
upside to the premium collected (see “PutWrite skinny,” page 30).
Option writing has always been viewed as a risky strategy, which
is why it makes sense to use it through an ETF structure. Recently,
with the historically low volatility, more retail investors are looking to
sell premium (see “Shrinking vol,” below).
“The strategy is in vogue; it produces substantial returns over
a longer period of time and customers that seek S&P exposure
coupled with anywhere between a 20% and 30% blend of the Put
Write ETF or that strategy creates for them a much higher riskadjusted return versus being long the S&P,” Looney says. “It is very
compelling from that standpoint.”
It provides yield in an environment
it is extremely tough to find
asset class not typically
Volatility as measured by the VIX has shrunk from already historic low levels.
yield. Looney expects to
Source: eSignal
see more of these options strategies
offered in ETF wrappers. “It is a
differentiator. It is impressive when
you look at the research and the
returns that these products can offer
over a period of time. It is not a shortterm play, we are not talking about
the VXX or some of the levered ETF
products linked to volatility assets;
those are a different animal,” he
says. “But from the standpoint of
strategy, generation of yield is easier
to achieve in the equity market
through the sale of options, given the
market’s bull run of the last couple
of years because those strategies
While options traders have turned to trading options on ETFs — as
mentioned above — the main value of creating ETFs was to allow
retail traders to access markets, strategies and asset classes in a
simpler fashion.
The Chicago Board Options Exchange (CBOE) has created
a series of benchmark indexes that use options strategies to
formulate returns. They have licensed ETF issuers such as Wisdom
Tree and ProShares to create ETFs based on those benchmarks
(see “Put indexes lower volume,” page 32).
“We are seeing significant interest in these products. Wisdom
Tree has licensed the Put Index (PUT) from CBOE, which sells
one month at-the-money options on the S&P 500 Index. The asset
growth in that is close to $200 million, up significantly in the last
60 to 90 days,” Looney says.
M o d e r nTr a d e r. c o m
Issue 536
“It is moving from being passive to
more of a structured product where
ETF issuers are using options as a
tool to provide additional yield.”
--Kapil Rathi
have really panned out, so investors are seeking a portion of their
portfolio dedicated to those strategies.”
Kapil Rathi, senior vice president for options business
development at CBOE, says the growth in ETF is a direct result
of retail and institutional traders taking a passive approach. That
passive approach is becoming more nuanced because of the
new products available for issuers to create. Why should a trader,
or RIA for that matter, learn the intricacies of options when they
can buy a ready-made ETF off of the shelf? “These customers
traditionally have not been that open to trading options. The ETF
market has been a step up giving exposure to the derivatives by
using ETFs as a mechanism,” Rathi says. “It is moving from being
passive to more of a structured product where ETF issuers are
using options as a tool to provide additional yield. It is going to be
great for the options and ETF industry.”
Looney reminds us that options have not been a part of these
traders’ or managers’ tool boxes. Their focus is on growing assets.
“What an ETF with an option-imbedded strategy does for those
customers is it requires no options paperwork and it requires no
transactional component, yet they benefit by having a professional
money manager manage the transactional component of the
options strategy,” Looney says.
“With the creation of the ETFs, it opens our world and the
options industry to a significant amount of new customers. If you
look at the major wire houses like Morgan Stanley or Merrill Lynch,
their financial consultants are not pushing transactional business,
they are pushing managed money business. So products like ETFs
with options imbedded strategies in them now becomes — pardon
the pun — an option for those customers who would otherwise not
be able to trade options. That is a huge potential growth factor in
the options business as a whole,” he says.
Rathi adds that more than 90% of RIAs are still not open to
trade options in their portfolio, but if you present that same return
they can generally get by using options in the form of an ETF and
all of a sudden it becomes a mainstream product easier for them
to understand. “As an RIA I don’t have to sign [paperwork] or
understand what a call or put is,” he says.
Options strategy ETFs provide an easy-to-implement tool
to professional advisors. “If a roboadvisor was to include an
options-based ETF strategy within their offering, or if a wire house
portfolio manager that manages an ETF basket includes these
products in their mix, the money flow into that product is going to
be meaningful,” Looney says. “It is a win-win for all parties. It is
a win for end users, it is a win for issuers of ETFs to differentiate
their offering and it is a win for CBOE to further educate, promote
and advance the uses of our products as well as the benchmark
products we have created.”
The active vs. passive myth
Too much is made over the active/passive debate. “What investors
are really doing now is finding the proper balance between active
versus passive strategies,” Looney says. “It obviously depends on
the audience. An institutional customer is going to seek a much
higher percentage of active management to justify the fees they are
paying the manager versus a retail customer. That being said, the
retail customer is getting much more astute about the fees they are
paying, especially with the advent of roboadvisors.”
Add that to the bull market environment since the equities
bottomed in March 2009, and it has been difficult for the active
manager to compete.
“We have seen global correlation levels plummet over the last
year; we have seen a significant uptick in the amount of sector
rotation, whether it be healthcare into financials, out of technology,
into energies, so on and so forth,” Looney says. “We see the
market starting to behave in a more normal capacity where sector
rotation is a bigger part of investment strategy as well as the mix
between large- mid- and small-cap.”
Seeking that balance is difficult because of the central banks,
role and the fact that these are
moving targets. “That is why you
are seeing ETF issuers seek index
The CBOE PutWrite Index produced superior risk metrics to S&P 500
licensing agreement to differentiate
during the last decade.
themselves,” Looney says. “To have
Source: CBOE
products available that permit a
customer to gain access to more
active strategies in somewhat of a
passive basket known as an ETF.”
October 2017
M o d e r nTr a d e r. c o m
The Wisdom Tree Put Write ETF has grown steadily since launching.
Source: eSignal
The breadth of index products has altered the active/passive
debate because the amount and variety of indexes allows investors
to pretty actively manager their portfolio with a diversified basket of
passive investments.
“The [word] passive is probably a misnomer, “Rathi says. “With
the advent of [trading] tools and education, the retail market is
better equipped, more knowledgeable and able to get almost the
same — if not better — returns than what an active manager was
able to provide them 10 or 15 years ago. I call it more advancement
of the industry. The control is shifting more to retail. It is not so
much passive versus active strategies, just a new way of trading.”
When traders can create a portfolio of passive investments that
capitalize on numerous asset classes and styles, that investor is
creating a pretty sophisticated portfolio that in total appears to be
more flexible, or active, than the sum of its parts.
Should retail write options?
For many people, the notion that scores of retail investors are
embracing options writing strategies is a flashing red warning
sign, similar to the anecdote of getting stock tips from your cab
driver. But Looney points out that investors have to operate in the
environment they are in.
“For people out there worried, they need to be just as worried
about their long SPDR position as they do about their short SPDR
put position, because if the market does roll over from its current
levels, both of those scenarios would be losses for the customers,”
Looney says. “If the market did see a sustained rollover, we
The breadth of index
products has altered the
active/passive debate.
M o d e r nTr a d e r. c o m
certainly could see investors seek to
use options for hedging purposes
as opposed to yield purposes. We
very recently have started to see
an uptick in trading flows in the VIX
options as well as the SPX options
that indicate institutional investors
are placing trades that would
benefit from a market pullback (see
“Breakout,” page 57).”
But we have seen several mini spikes in volatility since the
last major pull back in 2011. Traders always need to be vigilant.
“It seems to be playing into the geopolitical/domestic political
environment — with the new administration’s difficulties enacting a
policy agenda, the market is growing a bit impatient,” Looney says.
“Couple that with the geopolitical factors among Russia, North
Korea and the Middle East — they are all contributing to a high level
of investor angst.”
A problem for investors in the zero-interest-rate period is where
to go. “One of the things to consider is that the bond market is
extremely overvalued as well, so it is very difficult for investors out
there — whether institutional or retail — to find a cheap undervalued
place to put their money. Despite these risks, and despite this
nervous anticipation of a correction, we do see customers actively
engaging in strategies and growing the pie,” Looney says.
He adds that he has kept his eye on growth in assets under
management in the Put Write ETF. “I have seen assets under
management grow by close to $100 million during the past year.
Clearly investors see the value in these strategies.”
The development of various options strategies as well as their
distribution through ETFs has not only increased the ability of
traders to manager their own portfolio, it has fundamentally altered
the active/passive investing debate. “With the development of the
options-based ETFs that utilize CBOE index benchmark strategies
as the baseline for these, we now open the door for a new level
of customer penetration,” Looney says. “The ETF makes it much
simpler for the customer to engage.”
Not only engage but create portfolios that act more
like an actively managed investment than a basic index
investment or a standard actively managed mutual fund.
It appears that ETFs are providing the value they were
designed for.
Issue 536
Put writing indexes provide enhanced
risk-adjusted returns over long timeframes.
PUT a cap on drawdowns
Q By Oleg Bondarenko
The table shows annualized statistics from June 30, 1986 to
Dec. 31, 2015 on the PUT versus traditional benchmarks. The chart
shows performance over that period based on a $1 investment in
each of those indexes.
An analysis of the performance of the Chicago
Board Options Exchange’s (CBOE) two put
writing indexes — the CBOE S&P 500 PutWrite Index
(PUT) and the CBOE S&P 500 One-Week PutWrite
Index (WPUT) — indicated that they provided superior
risk adjusted returns to equity benchmarks. We
compared the put writing indexes to the performance of
traditional benchmarks, such as the S&P 500, Russell
2000, MSCI World and Citigroup 30-year Treasury
A cash-secured put-write strategy systematically
sells options collateralized by risk-free investment (U.S.
Treasury Bills). The CBOE PUT and WPUT Indexes are
designed to track the performance of a hypothetical
passive strategy that collects option premiums from atthe-money (ATM) options on S&P 500 Index, and holds
a rolling money account invested in Treasury bills (see
“How it works,” below). Both strategies attempt to profit
from high premiums of index options. The WPUT Index,
The profit/loss diagram shows the PutWrite Index valuation
at expiration. As you can see, the Index outperforms the
S&P 500 in down markets. It also outperforms the S&P
in moderately up markets up until the level of premium
collected, and then it underperforms.
Source: CBOE
October 2017
which was launched in 2015, extends the PUT strategy to weekly
S&P 500 options. Option premiums are collected weekly, instead
of monthly.
During an almost 30-year period, the PUT Index outperformed
the traditional indexes on a risk-adjusted basis. The annual compound return of the PUT Index is 10.13%, compared to 9.85% for
the S&P 500 Index. However, the standard deviation of the PUT
Index is substantially lower — 10.16% versus 15.26%. As a result,
the annualized Sharpe ratio is 0.67 for the PUT Index and 0.47 for
the S&P 500 (see “Long-term performance metrics,” above).
The data history for the WPUT Index, based on weekly options,
begins in January 2006. During the last 10 years, the PUT and
WPUT indexes delivered similar risk-adjusted performance and
both outperformed the S&P 500 Index and other benchmarks on
a risk-adjusted basis (see “Improving on what works,” right). The
annual compound return is 6.59% (PUT), 5.61% (WPUT) and
7.09% (S&P 500). The annualized Sharpe Ratio is 0.52 (PUT),
M o d e r nTr a d e r. c o m
During an almost 30-year
period, the PUT Index
outperformed the traditional
indexes on a risk-adjusted
The first table shows monthly statistics from 2006 through 2015 for the
PUT and WPUT versus equity benchmarks. The second table shows annual
statistics from the same period. The chart at the bottom shows performance
during that period based on a $1 investment in selected indexes.
Source: CBOE
0.50 (WPUT) and 0.46 (S&P 500).
Relative to the PUT and S&P 500 Indexes, during the
last 10 years, the WPUT Index has a lower standard
deviation, beta with respect to the market and maximum drawdown. In particular, the standard deviation
is 11.51% (PUT), 9.85% (WPUT) and 15.11% (S&P
500). The maximum drawdown is -32.7% (PUT), -24.2%
(WPUT) and -50.9% (S&P 500). The longest drawdown
is 29, 19 and 52 months, respectively. The WPUT appears to add an extra level of downward protection (see
“Drawdown data,” page 35).
Success of PUT & WPUT
The reason the PutWrite strategies have been successful has to do with the nature of implied and realized
volatility (see “Why it works,” page 35). The strategy
takes advantage of well-priced puts.
From 2006 to 2015, the average annual gross premium
collected for PUT is 24.1% and 39.3% for WPUT. Premiums for WPUT are smaller, but collected weekly instead
of monthly, which results in higher aggregate premiums.
Selling one-month ATM puts 12 times a year can
produce significant income. From 2006 to 2015, the average monthly premium is 2.01%. Selling one-week ATM
puts 52 times a year can produce even higher income,
but note that transaction costs can be higher with more
frequent trades.
Since launch of Weekly S&P 500 options, their
trading volume has increased dramatically. In 2015, on
average it was about 340 thousand contracts per day,
representing 36% of all CBOE S&P 500 options.In
2015, weekly options volume averaged about 340 thousand contracts per day, representing 36% of all CBOE
S&P 500 options.
High volatility premium
indicates that the index
options are richly priced.
M o d e r nTr a d e r. c o m
Oleg Bondarenko is Professor of Finance at
University of Illinois at Chicago, and he serves on
the Product Development Committee of CBOE.
This story is adapted from a white paper he wrote
that was commissioned by CBOE.
Issue 536
Notice of Class Action Settlements
If you transacted in Euroyen-Based Derivatives1 from January 1, 2006 through June 30, 2011, inclusive, then your
rights will be affected and you may be entitled to a benefit. This Notice is only a summary of the Settlements and is
subject to the terms of the Settlement Agreements2 and other relevant documents (available as set forth below).
The purpose of this Notice is to inform you of your rights in
connection with two separate proposed settlements with Settling
Defendants Deutsche Bank AG and DB Group Services (UK) Ltd.
(collectively, “Deutsche Bank”) and with Settling Defendants JPMorgan
Chase & Co., JPMorgan Chase Bank, National Association, and J.P.
Morgan Securities plc (collectively, “JPMorgan”) in the actions titled
Laydon v. Mizuho Bank Ltd., et al., 12-cv-3419 (GBD) (S.D.N.Y.) and
Sonterra Capital Master Fund, Ltd., et al. v. UBS AG, et al., 15-cv-5844
(GBD) (S.D.N.Y.). The separate settlements with Deutsche Bank and
JPMorgan (collectively, the “Settlements”) are not settlements with any
other Defendant and thus are not dispositive of any of Plaintiffs’ claims
against the remaining Defendants.
The Settlements have been proposed in two class action lawsuits
concerning the alleged manipulation of the London Interbank Offered
Rate for Japanese Yen (“Yen LIBOR”) and the Euroyen Tokyo Interbank
Offered Rate (“Euroyen TIBOR”) from January 1, 2006 through
June 30, 2011, inclusive. The Settlements will provide $148 million to
pay claims from persons who transacted in Euroyen-Based Derivatives
from January 1, 2006 through June 30, 2011, inclusive. If you qualify,
you may send in a Proof of Claim and Release form to potentially get
benefits, or you can exclude yourself from the Settlements, or object
to them.
The United States District Court for the Southern District of New
York (500 Pearl St., New York, NY 10007-1312) authorized this Notice.
Before any money is paid, the Court will hold a Fairness Hearing to
decide whether to approve the Settlements.
Who Is Included?
You are a member of the “Settlement Class” if you purchased, sold,
held, traded, or otherwise had any interest in Euroyen-Based Derivatives
at any time from January 1, 2006 through June 30, 2011, inclusive.
Excluded from the Settlement Class are (i) the Defendants and any
parent, subsidiary, affiliate or agent of any Defendant or any
co-conspirator whether or not named as a defendant; and (ii) the United
States Government.
Contact your brokerage firm to see if you purchased, sold, held,
traded, or otherwise had any interest in Euroyen-Based Derivatives. If
you are not sure you are included, you can get more information,
including the Settlement Agreements, Mailed Notice, Plan of
Allocation, Proof of Claim and Release, and other important documents,
at (“Settlement Website”) or by calling
toll free 1-866-217-4453.
What Is This Litigation About?
Plaintiffs allege that each Defendant, from January 1, 2006 through
June 30, 2011, inclusive, manipulated or aided and abetted the
manipulation of Yen LIBOR, Euroyen TIBOR, and the prices of
Euroyen-Based Derivatives. Defendants allegedly did so by using
several means of manipulation. For example, panel banks that made the
daily Yen LIBOR and/or Euroyen TIBOR submissions to the British
Bankers’ Association and Japanese Bankers Association respectively
(collectively, “Contributor Bank Defendants”), such as Deutsche Bank AG
and JPMorgan Chase Bank, N.A., allegedly falsely reported their cost of
borrowing in order to financially benefit their Euroyen-Based
Derivatives positions. Contributor Bank Defendants also allegedly
requested that other Contributor Bank Defendants make false Yen
October 2017
LIBOR and Euroyen TIBOR submissions on their behalf to benefit their
Euroyen-Based Derivatives positions.
Plaintiffs further allege that inter-dealer brokers, intermediaries
between buyers and sellers in the money markets and derivatives markets
(the “Broker Defendants”), had knowledge of, and provided substantial
assistance to, the Contributor Bank Defendants’ foregoing alleged
manipulations of Euroyen-Based Derivatives in violation of Section
22(a)(1) of the Commodity Exchange Act, 7 U.S.C. § 25(a)(1). For
example, Contributor Bank Defendants allegedly used the Broker
Defendants to manipulate Yen LIBOR, Euroyen TIBOR, and the prices
of Euroyen-Based Derivatives by disseminating false “Suggested
LIBORs,” publishing false market rates on broker screens, and
publishing false bids and offers into the market.
Plaintiffs have asserted legal claims under various theories, including
federal antitrust law, the Commodity Exchange Act, the Racketeering
Influenced and Corrupt Organizations Act, and common law.
Deutsche Bank and JPMorgan have consistently and vigorously
denied Plaintiffs’ allegations. Deutsche Bank and JPMorgan each
entered into a Settlement Agreement with Plaintiffs, despite believing
that it is not liable for the claims asserted against it, to avoid the further
expense, inconvenience, and distraction of burdensome and protracted
litigation, thereby putting this controversy to rest and avoiding the risks
inherent in complex litigation.
What Do the Settlements Provide?
Under the Settlements, Deutsche Bank agreed to pay $77 million and
JPMorgan agreed to pay $71 million into separate Settlement Funds. If
the Court approves the Settlements, potential members of the Settlement
Class who qualify and send in valid Proof of Claim and Release forms
may receive a share of the Settlement Funds after they are reduced by the
payment of certain expenses. The Settlement Agreements, available at
the Settlement Website, describe all of the details about the proposed
Settlements. The exact amount each qualifying Settling Class Member
will receive from the Settlement Funds cannot be calculated until
(1) the Court approves the Settlements; (2) certain amounts identified
in the full Settlement Agreements are deducted from the Settlement
Funds; and (3) the number of participating Class Members and the
amount of their claims are determined. In addition, each Settling Class
Member’s share of the Settlement Funds will vary depending on the
information the Settling Class Member provides on their Proof of Claim
and Release form.
The number of claimants who send in claims varies widely from case
to case. If less than 100% of the Settlement Class sends in a Proof of
Claim and Release form, you could get more money.
How Do You Ask For a Payment?
If you are a member of the Settlement Class, you may seek to
participate in the Settlements by submitting a Proof of Claim and
Release to the Settlement Administrator at the address provided on the
Settlement Website postmarked no later than January 23, 2018. You may
obtain a Proof of Claim and Release on the Settlement Website or by
calling the toll-free number referenced above. If you are a member of the
Settlement Class but do not timely file a Proof of Claim and Release, you
will still be bound by the releases set forth in the Settlement Agreements
if the Court enters an order approving the Settlement Agreements.
M o d e r nTr a d e r. c o m
(continued from previous page)
If you timely submitted a Proof of Claim and Release pursuant
to the class notice dated June 22, 2016 (“2016 Notice”) related to
the $58 million settlements with Defendants R.P. Martin Holdings
Limited, Martin Brokers (UK) Ltd., Citigroup Inc., Citibank, N.A.,
Citibank Japan Ltd., Citigroup Global Markets Japan Inc., HSBC
Holdings plc, and HSBC Bank plc, you do not have to submit a
new Proof of Claim and Release to participate in these Settlements
with Deutsche Bank and JPMorgan. Any member of the Settlement
Class who previously submitted a Proof of Claim and Release in
connection with the 2016 Notice will be subject to and bound by
the releases set forth in the Settlement Agreements with Deutsche
Bank and JPMorgan, unless such member submits a timely and
valid request for exclusion, explained below.
What Are Your Other Options?
All requests to be excluded from the Settlements must be
made in accordance with the instructions set forth in the
Settlement Notice and must be postmarked to the Settlement
Administrator no later than October 5, 2017. The Settlement
Notice, available at the Settlement Website, explains how to
exclude yourself or object. All requests for exclusion must
comply with the requirements set forth in the Settlement Notice
to be honored. If you exclude yourself from the Settlement Class,
you will not be bound by the Settlement Agreements and can
independently pursue claims at your own expense. However, if
you exclude yourself, you will not be eligible to share in the Net
Settlement Funds or otherwise participate in the Settlements.
The Court will hold a Fairness Hearing in these cases on
November 9, 2017, to consider whether to approve the Settlements
and a request by the lawyers representing all members of the
Settlement Class (Lowey Dannenberg, P.C.) for an award of
attorneys’ fees of no more than one-fourth of the Settlement Funds
for investigating the facts, litigating the case, and negotiating the
settlement, and for reimbursement of their costs and expenses in
the amount of no more than approximately $300,000. The lawyers
for the Settlement Class may also seek additional reimbursement
of fees, costs, and expenses in connection with services provided
after the Fairness Hearing. These payments will also be deducted
from the Settlement Funds before any distributions are made to the
Settlement Class.
You may ask to appear at the Fairness Hearing, but you do not
have to. For more information, call toll free 1-866-217-4453 or
visit the website
1 “Euroyen-Based Derivatives” means (i) a Euroyen TIBOR futures contract
on the Chicago Mercantile Exchange (“CME”); (ii) a Euroyen TIBOR futures
contract on the Tokyo Financial Exchange, Inc. (“TFX”), Singapore Exchange
(“SGX”), or London International Financial Futures and Options Exchange
(“LIFFE”) entered into by a U.S. Person, or by a Person from or through a
location within the U.S.; (iii) a Japanese Yen currency futures contract on the
CME; (iv) a Yen LIBOR- and/or Euroyen TIBOR-based interest rate swap
entered into by a U.S. Person, or by a Person from or through a location within
the U.S.; (v) an option on a Yen LIBOR and/or Euroyen TIBOR-based interest
rate swap (“swaption”) entered into by a U.S. Person, or by a Person from or
through a location within the U.S.; (vi) a Japanese Yen currency forward
agreement entered into by a U.S. Person, or by a Person from or through a
location within the U.S.; and/or (vii) a Yen LIBOR- and/or Euroyen
TIBOR-based forward rate agreement entered into by a U.S. Person, or by a
Person from or through a location within the U.S.
2 The “Settlement Agreements” means the Stipulation and Agreement of
Settlement with Deutsche Bank entered into on July 21, 2017 and the Stipulation
and Agreement of Settlement with JPMorgan entered into on July 21, 2017.
WPUT had even lower drawdown than PUT and market
Source: CBOE
Why it works
Historically, the options implied volatility has considerably
exceeded the realized volatility of the S&P 500 Index.
From 1990 through 2015, the average implied volatility, as
measured by the CBOE Volatility Index (VIX) is 19.8%, while
the average realized volatility is 15.5%, implying the difference
of 4.3% (see “Implied vs. realized,” below).
High-volatility premium indicates that the index options are
richly priced. As a result, put writing strategies have historically
delivered attractive risk-adjusted performance.
Source: CBOE
volatility (VIX)
S&P 500 Realized
Issue 536
Options allow traders to take a more defined
position on an underlying stock; Weekly options
take this benefit one step further.
Weekly Options:
A More
Precise Tool
Q By: Russell Rhoads
Short-dated options that expire on non-third Fridays,
commonly referred to as Weeklys, were introduced by the
Chicago Board Options Exchange (CBOE) in 2005. There was
little attention paid to them and the volume in these non-standard
contracts was modest. Five years later in May 2010, the first equity
Weeklys were introduced on five different stocks.
Presently, Weekly options are available for trading on more than
400 stocks, exchange-traded funds (ETFs), and equity indexes.
Depending on the day, the percent of overall options volume that is
attributable to Weeklys is anywhere between 35% to 50% across
the CBOE option market (see “Growing week by week,” below).
That chart shows the percent of average daily volume represented by Weeklys at CBOE from January 2011 to July 2017. In January
of 2011, about 6% of the volume at CBOE occurred in Weeklys.
At that time, there were only about 70 products (stocks, ETFs and
indexes) with Weeklys available. As mentioned above, that number
has grown to more than 400 products. In July 2017, 32% of volume
at CBOE occurred in Weeklys, which was a tad lower than the
record of 33% in October 2016.
Why Trade Weeklys?
The core to the success of Weeklys relates to the time decay
(Theta) nature of options. Theta measures the time value of an option, which dissipates at an accelerated pace the closer an option
gets to expiration. Traders are either attempting to take advantage
of time decay or they are trying to avoid it. Here are two examples
of how traders may trade time value. First, is an example of how
short-dated options that are in-the-money or have intrinsic value,
and how they may be used to trade a short-term outlook
for a stock.
When a trader purchases a call or a put on a stock,
Weekly options volume has grown steadily during recent years.
Source: OCC
the trader will most likely need the option to move in their
favor before the option value approaches a break-even
price. This extra price move that is required to reach
the break-even price relates to the time value added to
the options’ intrinsic value. Consider if Apple (AAPL) is
trading at $157.25 and in traditional monthly options.
To take a bullish position on AAPL a trader purchases an
AAPL 150 call at $10 that expires in a month. The payoff
for this option at expiration is shown in “Apple monthly,”
right). Note the break-even price for this trade is $160.
Now consider the same situation, but with available
Weeklys. A one-week AAPL 150 call could be purchased for $8. This means the break-even on the trade
is a little lower at $158. Therefore, if this trade is held
until expiration of the option, the stock only needs to rise
October 2017
M o d e r nTr a d e r. c o m
Source: CBOE
The most significant and actionable moves in an option
contract occurs in the final week until expiration. Weeklys
allow traders to trade this move four times a month.
Source: CBOE
Source: CBOE
75¢ to break even. Also, since there is very little time value in the
option, this call will more closely resemble that of the stock performance (see “An apple a week,” above).
On the second AAPL payoff diagram the stock only needs to
move up 75¢ to reach a breakeven point as opposed to $2.75 in
the case of the one-month option. Before Weeklys were available
on stocks, a short-term bullish outlook on a stock did not necessarily make sense as an option trade. The option price would not
replicate a move in the stock as well as a trader would hope due to
the amount of time left until expiration. Also, the cost of an option
may have involved too much time value to make an option trade an
attractive alternative to purchasing a stock.
The decay of time value
of at-the-money options
tends to accelerate as
expiration approaches.
M o d e r nTr a d e r. c o m
The decay of time value of at-the-money options tends to accelerate as expiration approaches. Before Weeklys were available
there were traders who would only get involved in the option market during expiration week to take advantage of this sort of option
price behavior. As an example of this sort of time decay behavior,
consider the iShares Russell 2000 ETF (IWM) trading at $135
with five trading days remaining until expiration. A five-day IWM
135 call is trading at $1.45. Five days later this option expires and
if IWM is at or below $135, the option will have no value. “A Theta
play,” above) shows the expected time decay for this 135 call, using the assumption that the underlying price does not move at all.
Note the dramatic drop in the value of this at-the-money call that
occurs during the last week of life for this option contract. Even
more impressive is the drop in the last day or two, which is the type
of time decay that would only show up once a month for traders to
take advantage of in the past. Now they have the chance to benefit
from this dramatic loss in option value through selling at-the-money
options on a weekly basis instead of just once a month.
One of the greatest benefits of options over an outright stock or
futures contract is the ability to take a more precise position based on where a trader believes the market will
go, or not go, and when. Weekly options drill down a
little further, allowing traders to take even more precise
Russell Rhoads, CFA, is Director of Education
for the CBOE Options Institute. @russellrhoads
Issue 536
Binary options are offered in several regulated markets to
allow retail traders an easy way to access market moves.
Binary Options
are Here to Stay
Q By Daniel P. Collins
Binary options are based on a simple proposition; will X
market reach Y level by Z time. Binary options ask a “yes” or
“no” question, the answer of which creates a certain outcome. Binaries trade between 0-100, if the answer to the question is yes at expiration, the option settles at 100; if the answer is no, it settles at zero.
It can be based on any underlying: a sporting event, election, economic report or unique situation, but is mainly based on existing markets.
The modern history of binary options is a relatively short and
sometimes ignoble one.
The Iowa Market was launched in 1988, using binary-type contracts as a way to educate people regarding markets and operating under a no-action letter from the Commodity Futures Trading
Commission (CFTC). They created binary contracts on the outcome
of elections. What was learned from this is that people putting
actual money down on an outcome were better at predicting those
outcomes than certain so-called experts. Putting money on the line
apparently created the incentive to do a little more homework. In
fact, there is a long history of presidential betting markets and the
idea that they have a strong predictive value.
In the early part of this century, a number of nascent binary option
exchanges — most of which were based outside of the United States
— were developed often on events such as sports.
“They weren’t exchanges; most of them were the offshore Cypriot
bucket shops at the time,” says Dan Cook, director, business development for the North American Derivatives Exchange (Nadex).
Cook says they were mainly based in countries with light regulations. “They were promoting binary options, but essentially it was
Futures markets have
long had a reputation for
eating new lightly funded
participants up.
October 2017
a bunch of bad actors that were taking people’s money,” he says.
“There were only about four or five technology providers. Some
would have 200 affiliates, which were white-labeled websites. That
was the difficult thing in trying to stop it. They would close one down
and another would pop up. They would be saying 70% returns in 60
seconds. There were a lot of bad actors in this space.”
There were also more serious ventures. Irish firm Intrade launched
as a prediction market in 2001 and operated Tradesports, which
offered contracts on various sporting events. Tradesports marketed
itself as a way underlying commercial interests could hedge their
exposure to wins and losses as well as a market for speculators.
At the time officials of the CFTC often chose to ignore many of
these markets, arguing that sports betting markets masquerading
as futures exchanges were more a matter for individual state gaming
commissions than the U.S. futures regulator.
Intrade itself offered a popular presidential election market where
traders could make bets on the outcomes of numerous U.S. elections. It became popular during the 2008 and 2012 elections and
did provide some support to the notion that there could be a market
where participants put up their own money.
“We filed for presidential election contracts around 2012 and the
CFTC said “No,” but you turned on CNBC and they are quoting the
Intrade markets every day,” says Cook.
Intrade had applied for Designated Contract Market (DCM) status
with the CFTC, but that was not granted and the market was closed
in the United States in 2013.
By this time the CFTC had better actively monitored some of the
more questionable binary option products and issued a
fraud alert in 2013 geared at binary bucket shops.
Real Markets
In 2004, Hedgestreet, which would later be purchased
by IG Markets and rebranded as Nadex, became the first
regulated DCM offering binary options. Users could open
an account directly with Nadex without having a clearing
M o d e r nTr a d e r. c o m
Volume growth on Nadex
Source: Nadex
arrangement with a futures commission merchant. All contracts
are fully collateralized so there are no margin calls. Nadex offers
contracts tied to underlying markets, including stock indexes, forex,
commodities and events. It offers weekly expirations, daily expirations and numerous intra-day expirations.
Futures markets have long had a reputation for eating new lightly
funded participants up. Numerous studies have found that most
new accounts bust out, usually because they are underfunded and
traders misuse the available leverage. “They want to be a trader and
they try and trade an oil contract and they have $10,000 in their
account. They don’t stand a chance with a $1,000-a-point move,”
Cook says. “What we wanted to do is give the average individual
a way that they could be active in the financial markets, but in a
sensible manner. They can trade the popular markets like gold and
oil based on those actual underlyings, but they can do it at a lower
cost with limited risk.”
In its early days as Hedgestreet, Nadex toyed with the idea of
creating contracts for potential hedgers where no market existed,
such as gas at the pump, but more recently it has focused binaries
on popularly traded markets.
“What is popular are markets that people know and see on the
news every day. They wanted to participate but they didn’t have
the opportunity,” Cook says. “People like to trade currencies, but
currencies are elusive because of high leverage. They were trading
very large contracts. They were able to do that because of the high
“What is popular are
markets that people
know and see on the
news every day.”
--Dan Cook
M o d e r nTr a d e r. c o m
leverage, which is great if it is moving in your favor; but as
you know if it moves rapidly against you, people’s accounts can get crushed.”
Nadex has grown in popularity, and volume (see “Growing an exchange,” left). It has added market makers, and in
2010 allowed for trades to be intermediated, though most
customers still trade directly through exchange accounts.
Tom O’Brien and his son, Tommy, COO of TFNN, not
only trade binaries but also operate TFNN Corp., a fulltime trading education business with live content all day,
talking trading and taking calls with a variety of hosts.
Tommy trades binaries and directs many traders to the
contracts. He says many new traders are part-time traders
without the ability to monitor positons 24 hours, so the
defined risk nature of binaries is a huge benefit. “Defined
risk is a huge deal,” Tommy says. “They know that if they
are putting up $25 to get $75 that is all they are putting
up. We all know the currency markets are brutal. It is a
safer way to do it. They can start out small with recreational trades; the barrier to entry is not very large, they
don’t have to wire in $10,000.”
He adds that they want to be in the market and they want defined
risk. “They know they are not going to wake up in the morning and
find out they lost $10,000; if they got a couple of thousand at risk,
they got a couple of thousand at risk and they know what the risk is.”
O’Brien says, “I trade gold all of the time, but I will never trade
it again in the futures market. It doesn’t make sense because the
spreads on Nadex are $1 at most. Gold is going to bust up or down
$10 in a heartbeat. They can trade gold $6 in-the-money with a couple
of hours to trade. That can move. That is a low risk, high reward trade.”
They take advantage of the intraday contracts to trade economic
reports and news. “When [the EIA oil inventory report] is coming
out at 10:30 and [hourly] binaries are expiring at 11 or noon, and
your option is at 5; that is a small amount of premium you are paying when news is breaking. There can be a lot of volatility on those
numbers,” Tommy says.
They also can trade volatility by buying an option strike below the
market price and selling one above it. “If gold is trading at $1,200 per
ounce, you buy a binary at 1210 [and] you sell a binary at 1190. You
are looking for a $10 up or down move. And a $10 out-of-the-money
binary is going to be really affordable in gold,” Tommy says. “You are
paying maybe $20 on each side, so you are putting up $40 in total,
and if one of them expires in-the-money you get $100 in value.”
O’Brien says having defined risk allows traders to make bets
before news and in volatile markets too risky for straight futures,
such as during the recent presidential election spike. “I wouldn’t
have wanted to be trading futures that evening, but it made
sense with binaries.”
Jim Prince is head trader and educator with the Greatest
Business on Earth, an educational portal for,
who initially looked at binaries a few years ago and is now
hooked and encourages new traders to trade them. “People
get involved in trading and are often undercapitalized. Binaries gave that individual a good opportunity,” he says.
Issue 536
Source: NYSE
Apple (AAPL)
Amazon (AMZN)
Alibaba (BABA)
Boeing (BA)
Conoco Philips (COP)
iShares MSCI EAFE Index (EFA)
iShares MSCI Emerging Markets Index (EEM)
iShares MSCI Brazil Index (EWZ)
iShares China Large Cap ETF (FXI)
Gilead Sciences inc. (GILD)
Market Vestors Gold Miners ETF (GDX)
iShares Russell 2000 Index ETF (IWM)
McDonald's (MCD)
Netflix Inc. (NFLX)
Proctor & Gamble (PG)
Powershares QQQ ETF (QQQ)
iShares Barclays 20+year T-Bond (TLT)
United States Oil Fund (USO)
Ipath S&P 500 VIX (VXX)
Financial Select Sector ETF (XLF)
Energy Select Sector SPDR (XLE)
Exxon (XOM)
“As I started to delve into it, one thing jumped out: capitalization —
you didn’t need to lay out a bunch of capital. That has always been
[difficult] for newbies. They open up an account for $5,000, blow
through that and never come back. You can open up an account for
$250 at Nadex and try your hand and still experience some of those
emotions. That and the aspect of risk. Whenever you open up a
trade you have a known risk.”
Prince has developed a binary trading course. “It is a great launching point; I don’t care if you have $250 or $250,000 to trade with, if
you don’t understand how the markets work, it is not going to matter.
Binaries allow you to start with a small amount at your own pace. It is
a fantastic tool to begin your trading career with.”
After being the only regulated exchange for a while, Nadex is now
facing more legitimate competition. The Cantor Exchange lists binary options on forex markets and has recently offered weather market binaries.
Working with AccuWeather, Cantor offers contracts on hurricanes
tied to specific zip codes, rain days, and will soon offer snow contracts. As opposed to Nadex, Cantor is looking at creating markets
that are particularly appropriate for the unique attributes of binaries.
“Our interest is mostly trying to figure out where binaries have a
real strong economic purpose, says Richard Jaycobs, president of
Cantor Exchange. “Weather is a perfect example. If it snows and
somebody has to pay someone to plow their parking lot, that is real
October 2017
money. We are looking at a whole new class of binaries and weather
is the best example of that.”
Cantor offers protection for a hurricane landfall. “You can actually
go out and say, I have a house on the Jersey shore and if a hurricane
landfall occurs within 75 miles of the zip code that my house is in, I
want to get paid, maybe the amount of the deductible I have on my
insurance,” Jaycobs says. “If you buy a binary contract and a hurricane happens near your house this season, it may cost me $800 to
$1,200 to get $10,000 worth of protection. We think those are more
interesting kinds of contracts.”
The contracts are listed on and are valued at $1, so you
basically buy the specific dollar amount of protection you are looking for.
Cantor has two other weather-related contracts on rainfall.
Small businesses that depend on vacation rental income can
hedge the cost of bad weather. Right now it is only in the
vicinity of Atlantic City, but the goal is to expand regionally
and nationally.
“The product that people want — and this is the key part of our
strategy — varies by area. There are some areas where people don’t
care about rain, they care about wind; there are some areas where
they don’t care about rain or wind, they care about hail damage. We
have the technology to get very particular with risk and offer them,”
Jaycobs says.
Their target customers are small businesses up to institutional.
People hedging exposure of $10,000 to $100,000. “All of it focused
on trying to identify some hedging community that can benefit from
the product, which is not insurance but fills a gap in what insurance
would do and nothing,” Jaycobs says.
Equity Binaries
Both Nadex and Cantor are regulated by the CFTC, but more
recently the NYSE has moved into binaries with Binary Return Derivatives (ByRDs), which are binaries listed on underlying equities and
exchange-traded funds. Because of this, they are regulated by the
Securities and Exchange Commission and must be intermediated.
Currently there is one brokerage platform, Ally Invest, which recently
bought Trade King, that offer ByRDs.
The market, which launched in March 2016, is targeting mostly retail investors who want to generate income with known risk. Contracts
are valued at $100 and are listed five weeks out, expiring every Friday.
An added complication is that contracts are settled to the volume-weighted average price, which can vary more in value than the
actual underlying settlement.
It is an easier product to understand and trade than regular
equity options. It is a limited risk/limited reward product that can
generate income with known risk. Like all binaries there is no
leverage invovled. There is no risk of buying stock or selling stock.
There is no tax implication of selling stock.
ByRDs are just getting started and have their own unique challenges, but they benefit from previous binary markets.
Binary options offer a simpler way to speculate on a known market
or create a new market based on their simple metrics. Every trade can
be broken down to a “yes” or “no” question with precise odds based
on a value from zero to 100. They appear to have come of age.
M o d e r nTr a d e r. c o m
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makes waves,
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Options-based trading strategies have always been
a niche, but like all trading strategies, options-based
strategies are getting more complex.
Volatility as an
Asset Class
Q By Daniel P. Collins
The history of managed money in the futures world since
its early days in the 1980s has been about one thing: Trend
following. However, a niche strategy that dates to the first options
on futures contracts has been option writing. Prudent traders
since the launch of options have used the product to mitigate risk,
but there had to be someone on the other side of those defined
risk long options positions.
Soon strategies were developed to earn consistent returns by
selling option premium. For a majority of the trading community,
options were a one-way tool, so options sellers had the advantage
of setting their own price.
When founder of Warrington Asset Management Scott Kimple
started trading options more than 20 years ago, most options
managers were pure premium sellers. “Back then before tech
homogenized a lot of trading and got everyone on the same
valuation models, you did have some pretty extreme options
mispricings,” Kimple says. “My mentor was a pretty aggressive
premium seller and [earned] amazing returns taking advantage of
those mispricings.”
Option selling strategies had a reputation for producing strong
returns for several years before a volatility spike came and wiped
many of them out. As soon as it was over there were people
to take their place, or the same strategies rebranded to avoid
meeting a high-water mark following deep drawdowns.
“They were either long-term sellers or short-term [sellers] trying to
get within the inflection point of time decay,” Kimple says. “Now you
have some fairly sophisticated players in multi-billion dollar shops
and there has been more sophistication that has come into it.”
That sophistication, and the broader acceptance of selling
premium as a strategy (see “Options on ETFs & ETFs on options,”
page 28), has made things tougher for premium sellers. More
traders are willing to take the other side of option trades. “People
didn’t really understand options; the technology that we have
today in terms of rapidly being able to adjust option prices based
on models didn’t exist,” Kimple says. “You did see wide markets.
Back then you would get into a fast market, the few market makers
would blow the spreads up $5, $10, $15 wide and would make
their month on a couple of fast markets. Efficiency has been
added that has minimized the number of fast market conditions.”
There was still risk. “It might have been easy for the real good
ones but with that extreme volatility in those mispricings, it
was more like the Wild West,” Kimple says. “The business had
become more institutionalized, technology has probably leveled
the playing field, there is more advanced work on options and
options pricing, and there are more option specialists.”
The Year 2008
As noted above, premium collection strategies have come in
and out of fashion, but the 2008 credit crisis meltdown knocked
many out of the game. Even the best practitioners of the strategy
realized that they would never move to the next
level of money management until they dealt with the
inherent risk associated with pure naked options
writing. One firm that earned outside returns for
several years — LJM Partners — decided to alter
their approach following the crisis. Actually, LJM
had already offered more measured strategies with
lower risk and less dependence on pure premium
writing, but after 2008 it incorporated some of those
methods into all of their strategies. It involved adding
long options positions that reduced risk and its
The industry produced a
wrath of innovative options
strategies after 2008 that
sought to harness underpriced
options in addition to simply
collecting premium.
October 2017
M o d e r nTr a d e r. c o m
reliance on premium collection.
“Our Aggressive strategy, which was a pure option writing
strategy now shares a lot of the characteristics of our more
conservative programs; this is because we have found that that is
a much more efficient way to avoid those steep drawdowns like
we had in the Aggressive Program in 2008,” says Lauren Savino,
managing director, LJM Partners.
LJM’s Aggressive program earned 68.10% in 2003, 53.76% in
2004, 42.21% in 2005, 37.71% in 2006 and 21.25% in 2007 before dropping 48.05% in 2008. Its Moderately Aggressive strategy
also gained more than 20% in each of those years before losing
18.69% in 2008. Its Preservation and Growth Strategy earned
12.12% in 2008. “We added some long put positions in the portfolio
that would offset some of that true options writing exposure, that is
how that strategy was positive in 2008,” Savino says. “The philosophy was that pure option writing wasn’t for everyone so we wanted
to create a risk/reward profile that was more appropriate for an
investor that has a lower risk tolerance.”
LJM’s performance during that period was superior to most
similarly geared options strategies — even the Aggressive.
LJM was not alone. The industry produced a wrath of innovative
options strategies after 2008 that sought to harness underpriced
options in addition to simply collecting premium. This trend grew
so noticeable that we dubbed this group “volatility value traders.”
They were not all the same, but each utilized long option positions
to hedge exposure to pure naked option writing and, in some
cases, sought returns from underpriced premiums.
An added bonus for these managers was that institutional investors were all of a sudden picking up the phone. Once they were
volatility value traders instead of simply naked option writers, there
was more institutional interest. The growth and growing validation
of the CBOE Volatility Index (VIX) helped legitimize volatility as an
asset class. It also gave tools to hedge volatility exposure.
Instead of being ignored by institutions, some option managers
are being actively courted. “Today, even when you talk to pension
endowments some of the big institutional investors, they put out
RFPs for option writing strategies to bring in a certain amount of
income,” Savino says. “That is a big shift from my first few years
working at LJM.”
LJM has even launched a 40-Act version of their Preservation
and Growth Strategy and are managing about $650 million in it.
“That is actually where most of our assets are today. It is a very
different space from when we were just a CTA,” she adds.
“Liquidity, volatility, open outcry and technology are the four
big significant changes in [the space],” Kimple says. “Liquidity
used to be kind of thin in the short options space, that has been
somewhat democratized.”
He adds that the advent of weekly options has improved
liquidity. “When I started there was one options expiration per
month. Now you have got multiple expirations. You see these big
banks come in and participate in Weeklys.”
LJM still earns money through collecting premium, but is better
protected in the case of a volatility spike and can earn positive
returns from long option positions. “We are always net short
[volatility] whether volatility is high or volatility is low,” Savino says.
“The majority of the time there is still going to be a positive spread
between the implied volatility and realized volatility. That is what
we have seen for the last 18 months. So even though we have
seen volatility trending lower — when you look at VIX as a measure
of volatility — the realized volatility has also been significantly
depressed for a long period of time.”
That said, LJM includes long volatility positions in their portfolio
to offset risk. “We always try to stay neutral when it comes to the
market but there is a short [directional] bias just based on the fact
that we want to offset some volatility risk,” Savino says.
Robb Ross began trading options in the late 1990s when
volatility was high. He saw S&P
options providing a premium of
12% on at-the-money options 30
While volatility has gone through extended periods when it was depressed before, the
days out. “That was the price of
vast majority of days the VIX has settled below 10 occurred in 2017.
fear in the market for what people
Source: eSignal
are willing to risk to sell you safety,”
Ross says. “I [thought at the time],
there is a way to take advantage
of this without just being a straight
option seller.”
He developed his Alternative
Hedge Program, initially dubbed
Scantily Clad straddles (see:
Options naked straddles: A more
modest approach,” Futures, January
2011), which is a Delta covered
premium strategy. While unique,
the strategy followed the trend
of accessing the value of option
premium while maintaining solid risk
management models.
M o d e r nTr a d e r. c o m
Issue 536
Volatility has contracted so much that many
traders are asking if the VIX is broken. Kimple points
out that of the 26 instanced where VIX closed
below 10; 17 of those have occurred this year (see
“Shrinking vol,” page 43).
“We think the markets will regress to more normalized
volatility patterns at some point,” Kimple says.
The question is, if prepared, will all these managers
and traders trading volatility short? Folks like Kimple
and LJM have navigated numerous volatility cycles.
--Scott Kimple
“My competition is an option trading program that
has a track record from 2012; if they have got doubledigit returns, they are selling volatility,” Kimple says.
that managers who have maintained those strong
Back to the future
the low volatility period between 2013-2017, they
While firms like Warrington and LJM have survived and thrived
are taking on too much risk. “The only way they have been able
through multiple market cycles by including prudent use of long
to do that is by ramping up their risk and when — not if — volatility
option positions and not being completely exposed to the forces
increases; these are going to be the guys taken out on a stretcher.
of volatility; pure premium selling appears to be on the rise.
That is always the case (see Volatility cycles,” below).”
“The big story is this untried untested central bank activity has
Kimple adds, “People say to us, ‘Your returns aren’t what they
caused volatility to be abnormally low. It has caused an interest
[used to be],’ We say that is because we are good risk managers.
in the space, especially in short volatility,” Kimple says. “The only
You have options traders that have made strong returns over
way to make money the last couple of years has been in the short
the last few years because they have been taking excess risk.
volatility space. It has caused a dramatic increase in structured
The canary in the coal mine for these guys is if you look at their
product related to getting short volatility. You have volatility
intermonth returns for January/February 2016, August 2015
tourists; people who are relatively new to the space who have
and October 2014.Their intermonth drawdowns would be very
come in – realizing the only way to make money is selling volatility
instructive and would be a bit scary.”
— doing it in a highly risky fashion.”
The options-writing strategy is more accepted by both
Kimple says the trade may last for a while but warns that it is
institutional and retail, and it could be happening at the wrong time.
crowded. “Recently when volatility has picked up [traders have]
come in and smashed it back down. However, at some point when
“My concern is if that acceptance is based on people who know
it comes unhinged, like it did in January and February in 2016 –
what they are doing and who are able to sustain the next volatility
the last time we had an extended period of higher volatility —these
spike?” Kimple asks. “It is frustrating that every time we’ve gotten a
guys are going to get creamed.”
volatility spike it is a matter of hours or days before it is fully retraced.
That is not normal, it is a direct result
of central bank activity [and it] is
something that can’t last forever.”
The VIX experienced multiple years of depressed volatility prior to the market crashes in
Kimple may sound like Chicken
2000 and 2008.
Little, but at some point the market
Source: eSignal
will have an extended volatility spike,
and there are more people short
volatility than ever before.
“That is what is going to test
the current generation of volatility
traders,” Kimple says. “What
happens when you have a Dow
that drops 1000 points and doesn’t
bounce back and take out the all-time
high, a day, a week, a month later?
What happens when the market
goes down and stays down?”
If we know anything about the
markets, it is that it will happen. The
question is when and how prepared
you are for it.
“Every time we’ve gotten a
volatility spike it is a matter
of hours or days before it
is fully retraced. That is not
normal … it is something
that can’t last forever.”
October 2017
M o d e r nTr a d e r. c o m
That’s a question that many investors are asking about retail companies as Amazon continues to digest more and more market share of the U.S. retail sector.
But there’s another group of people who think that antitrust laws could carve up Amazon.
This month, we dig into the antitrust speculation, analyst expectations and Amazonization
of the American economy.
Amazon’s effect on the economy has been dramatic
and there are legitimate antitrust concerns, but
any attempt at a fix may be fraught with risk and
potential unintended consequences.
Breaking Up Amazon…
It’s Not That Simple
Q By Garrett Baldwin
In June 2017, The City University of New York (CUNY)/
Queens professor of digital economics Douglass Rushkoff
penned one of the more compelling arguments on the future of
Amazon (AMZN) and the U.S. economy.
His title was simple: “It’s Time to Break Up Amazon.”
The thesis came in the wake of Amazon’s $13.7 billion bid for
Whole Foods (WFM), a move that led to a sharp sell-off of grocery
rivals’ stocks. The Amazonization of the American economy is rife
with concerns about the effect on labor, anti-competitive threats and
chatter about a potential monopoly that will suck value out of every
market Amazon enters. With 30% of all online and offline retail sales
growth and 40% of Internet cloud service demand, what will stop
Amazon from dominating everything?
More important, what exactly has helped the company reach this
Rushkoff explains that past antitrust efforts to end monopolies in
the 20th century industrial economy centered on efforts to prevent
companies from gaining control of the distribution platforms.
Whether it be a trucking company trying to control roads, an oil company owning pipelines or a telephone company owning the wires;
the distribution platform is a critical consideration.
In this digital economy, the ecommerce “platform is the business.”
Rushkoff writes, “Netflix content sells its platform, Apple’s devices
sell its supposed ‘ecosystem.’ Amazon’s book business, like Uber’s
cab business, was just an easy foothold—the low-hanging fruit of an
existing but inefficient marketplace—through which to establish a
platform monopoly. From that beachhead, the company then pivots
to other verticals.”
Amazon has a unique competitive advantage that provides key
research data that competitors simply lack. Amazon had 43% of
all online retail sales in 2016, according to Slice Intelligence. As an
individual product category grows in popularity, Amazon can then
develop its own private label version of the product and begin to sell
it on the platform in direct competition.
From there, Rushkoff proceeds to argue that the company doesn’t
consider its long-term influence as it expands. In the digital age,
Rushkoff argues that Internet services and
capital can scale up in a way that real companies and the real world cannot in the future.
Rushkoff is arguing, in theory, the idea that
Amazon’s monopoly potential is unlike anything that the world has seen. Not only is it a
threat to capitalism, but it is also a potential
dagger into the heart of the world economy.
While the author seems uncertain that
On the matter of antitrust issues,
there is a fine line between
technological progress and the goals
of breaking up firms due to market
share growth tied to that progress.
M o d e r nTr a d e r. c o m
Issue 536
current antitrust regulations can be applied to this issue, his article
is the reason we are exploring this issue today. For a better understanding of Amazon, the current state of antitrust laws and why this
company is unlikely to face legal retribution, we turned to an expert.
We sat down with Diana Moss, president of the American Antitrust Institute (AAI) in Washington, for more insight into Amazon’s
legal issues, problems facing antitrust advocates and a better understanding of the role of digital platforms in the 21st century economy.
Moss, an economist who has been with AAI for 17 years, argues
that Amazon’s story is part of a broader narrative on antitrust issues
that have been building for three decades.
“Over 30 years of lax enforcement with declining competition,
as indicated by higher levels of market concentration, we’ve got
growing inequality gaps, slower rates of market entry and a number
of other problems,” she says.
However, in the case of Rushkoff’s argument, she unpacks a
handful of issues at the heart of Amazon’s platform and antitrust
“The development of the online platform and the coverage of platforms across multiple, adjacent markets on which other technologies
reach is — from an economics standpoint — not a new idea. Network
platforms and interoperability are old, fleshed out economic ideas.
What is interesting is how enforcement approaches them,” she says.
At the core of the issue on the platform is the economic concept
called the essential facility.
“The essential facility is typically a network — whether it’s a
transport system, a pipeline, a transmission system, a railroad — that
displays, in many cases, natural monopoly types of characteristics.
For market entrants, rivals and competitors to reach the consumer, they have to go through the essential facility. They have to gain
access because it really doesn’t make sense in some cases to have
more than one big network,” Moss says.
In the public utility, having more multiple transmissions lines would
be duplicative and wasteful. For this reason, the markets have true
monopoly regulation. However, Moss notes that online platforms are
a way to think of modern essential facilities that are based on digital
She notes, however, that this doesn’t necessarily require regulation.
“Regulation is really reserved to the most extreme mortgage
failures that we can identify in our economy. There is a lot of talk right
now about regulating these platforms. We do not think that’s a great
idea at all. ”
At the core of this sentiment is the notion that Amazon and Google (GOOG) are not carbon copies of the old essential facilities and
networks that the United States saw in the 20th century manufactur-
ing and transportation-based industrial economy.
“We still have regulation in many public utilities because of these
older facilities. But online platforms as essential facilities are different. There has to be some form of access to the facility, to the technology, to the platform, so that rivals can operate on top, adjacent to,
or in a complimentary non-restrictive way to bring value, new products and services to consumers,” Moss says. “Antitrust [experts] are
grappling with this over these platforms. What is complicating this is
that the Googles and the Amazons and the Facebooks of the world
have engaged in acquisitions and consolidation in markets that may
not immediately raise antitrust concerns.”
On the matter of antitrust issues, there is a fine line between
technological progress and the goals of breaking up firms due to
market share growth tied to that progress. Moss argues that the
future requires more than just thinking about the concept of breaking
up monopolies or platforms.
“You can’t stop innovation,” Moss adds. “I don’t think we all want
to be Luddites. Technological progress brings many benefits in
many ways, but it is a process that requires more guidance and
structure through a more coherent policy that includes more than
just antitrust. Antitrust is really important, but when it comes to
promoting competition in the economy and technological progress,
you need a national policy on promoting innovation that’s pro-competitive and pro-consumer.”
The Path to Antitrust
Is it possible that Federal agencies or a state’s attorney eyeing
a governor’s mansion will target Amazon in the months or years
ahead? It depends on the context.
“One thing antitrust must do is continue to look forward,” Moss
says. “All merger analysis is forward-looking; it looks at markets,
not as they currently are but as they are likely to be. Antitrust has to
broaden the lens within using existing tools to make the connections
between the types of acquisitions and consolidations in conduct in
these very complex ecosystems that the platforms live in. And to do
that, you need smart, creative, aggressive enforcers.”
She adds that the current political environment isn’t up to meeting
those challenges; citing the lack of leadership at key agencies, unfilled positions and the threat of using anti-trust as a political weapon
instead of smart policy.
In the current environment, Moss doesn’t expect that the Federal
Communications Commission or the Department of Justice would
bring a large antitrust case against Amazon. The idea that the agencies would bring an amorphous case that posed concerns about
competition and how Amazon might be leveraging its market power
doesn’t lend itself to the current system.
“The laws and the guidance of the agencies are not
built that way,” Moss says.
It is more likely that agencies would address Amazon
the same way that we have witnessed antitrust efforts with
Google in recent years.
“They would look at conduct, how the platforms
conduct themselves, and whether they’re engaging in
exclusionary conduct that’s limiting competition and or
Is it possible that Federal
agencies or a state’s attorney
eyeing a governor’s mansion will
target Amazon in the months or
years ahead?
October 2017
M o d e r nTr a d e r. c o m
misdirecting resources. Or they would look at mergers and acquisitions,” Moss says.
If agencies bring a case against Amazon and Whole Foods,
Moss argues they would take a fairly specific view to that particular
transaction and how it affects competition. In this case, they may
examine the space of procurement of natural and organic foods, and
the logistical distribution segment in terms of how those products
are distributed to consumers.
“It has to look through the lens of merger control by defining
markets and looking at how the transaction could harm consumers,
choice and innovation; and how it would affect price. And then the
answer will be whether there is a competitive issue or not. Antitrust
has less ability to bring much broader concerns to bear on how
a company is behaving in its ecosystem. There has to be a hook
through the law, she says.
Moss adds that there is a possibility that Federal agencies bring
a case over Amazon and Whole Foods. It may come down to how
much competitors begin to complain.
“The agencies really listen hard to how other smaller firms are
going to be affected by this type of transaction,” she says. “The more
vocal smaller entrepreneurial, innovative competitors can be about
this type of consolidation, the more it will get on the radar screens of
the agency. The problem is they have to sort of beat the fear factor,
the intimidation factor.”
Such drum-beating is common in the agribusiness industry. However, companies that step forward and compete do fear retaliation.
“We saw, this was an issue in Sysco-U.S. Foods. There were smaller
alternative suppliers and food systems that absolutely would’ve been
affected by that. But they think twice about stepping forward because
they’re dealing a very large and powerful company,” Moss says.
However, when it comes to Amazon’s platform, antitrust will
remain on alert but open to growing progress.
“Technological innovation, digitalization, development of platforms
is fine, as long as antitrust takes an active role in promoting one of
two strategies. One is to promote access to platforms. We call this
intra-system competition. So that’s having a Google or an Amazon
[with] an access system that is really open and non-discriminatory.
And because folks have to use a platform that that access is open
and available.”
Moss’ other strategy is that antitrust groups promote the development of multiple platforms that compete head to head.
Unfortunately, it appears that we operate in a world right now
that doesn’t have either strategy in place. “We have neither good
intra-system competition where you know because we see competitive issues emerging around the platforms; nor do we have good
intra-system competition because we don’t have competing, multiple
platforms,” Moss says.
In the end, there may be an attorney general in a state somewhere
who is eyeing the governor’s mansion who will want to generate a
name. The laws are not in the favor of anyone seeking a broad swipe
at the firm. More important, the acceleration of the Amazon economy
will continue, and simply breaking the firm up into separate pieces
certainly isn’t going to alter the decline of jobs and dramatic overhaul
of the economy.
Amazoned! The threat Amazon is
posing to competitors and potential
companies. A Barron’s writer argued that grocery
stores were largely immune from Amazon because
Americans like to go to the grocery store. Another
writer on April 1 argued that Home Depot (HD)
and Lowe’s (LOW) held “a rare position in retailing:
They are virtually Amazon-proof.”
Perhaps Jeff Bezos was listening as this summer
Amazon entered the grocery business in a big
way with its planned acquisition of Whole Foods
(WFM). And Amazon’s deal to sell Kenmore
products from Sears led to a short-term dip across
the board in the home improvement space.
The creeping threat of Amazon has even led to a
new word entering the English Dictionary. The term
“Amazoned” – the destruction of value by ecommerce – has been
pitched and is awaiting consideration from the Collins Dictionary.
To gain an understanding of how significant Amazon’s threat to
potential competitors is, we reached out to our friends at Sentieo,
a digital research platform that helps investors identify trends and
unique investment stories. The hedge fund platform revealed an
interesting trend.
During the last few years, we’ve seen more and more
How Big of a
Risk is Amazon?
Q By Garrett Baldwin
Amazon’s increasing reach across the global economy
has been nothing short of remarkable during the last
decade. While the brick-and-mortar retail sector has experienced
the most pronounced decline in the last decade, Amazon saw an
increase in market capitalization of 1,910% from 2007 to 2016.
We have witnessed financial publications speak of Amazonproof companies during the last 12 months. At the forefront,
Barron’s had listed companies in the grocery business and
the home improvement retail industries as “Amazon resistant”
M o d e r nTr a d e r. c o m
Issue 536
It may come down to
how much competitors
begin to complain.
companies list Amazon as a”primary threat” in its competitive
risk section in their annual report. Dozens of companies list their
reliance to Amazon Web Services and Amazon’s distribution
platform for sales. But we were more interested in the 68
companies that view Amazon’s increasing migration into their
core activities as a threat. That is more than President Donald
Trump poses to the markets.
And the spectrum is quite revealing.
First, one must be intrigued by the growing threat Amazon has
presented to the music and entertainment industry. Second, more
and more major companies with strong growth potential and
reliable cash flow are dedicating larger portions of their
Form 10-K to address the competitive threat.
This story opens up a broader debate on one of the growing
agreement that reporting threats needs to improve for investors.
In 2014, an ACCA report indicated that investors are increasingly
concerned about the quality of risk reports. A conference
determined that 80% of respondents argued that companies
Here is a list of companies who have identified Amazon as a threat to their business.
U.S. Auto Parts Network, Inc. (PRTS)
Endurance International Group (EIGI)
8x8, Inc. (EGHT)
New Relic (NEWR)
Red Hat (RHT)
Otelco Inc (OTEL)
Internap Corp (INAP)
LogMeIn Inc (LOGM)
CDW Corp (CDW)
Vonage Holdings Corp. (VG)
Godaddy Inc (GDDY)
Gigamon (GIMO)
CSG Systems International, Inc. (CSGS)
Shutterfly, Inc. (SFLY)
Brocade Communications Systems, Inc. (BRCD)
Hewlett Packard Enterprise (HPE)
Quotient Technology (QUOT)
ITEX Corporation (ITEX)
Alphabet (GOOGL)
CommerceHub Inc (CHUBA), Inc. (OSTK)
Etsy Inc (ETSY)
Liberty Interactive Corp (QVCA)
Wayfair Inc (W)
Priceline Group Inc (PCLN)
Mercadolibre Inc (MELI)
Liberty Tripadvisor Holdings Inc (LTRPB)
Tripadvisor Inc (TRIP)
October 2017
Barnes & Noble Education (BNED)
Dream Homes & Development Corp (DREM)
MSG Networks (MSGN)
News Corp (NWS)
Viacom, (VIAB)
Netflix, Inc. (NFLX)
World Wrestling Entertainment, Inc. (WWE)
TiVo Corp (TIVO)
E. W. Scripps Co (SSP)
AMC Entertainment Holdings Inc (AMC)
Trans World Entertainment Corporation (TWMC)
Shenandoah Telecommunications Company
Harmonic Inc (HLIT)
Neulion Inc. (NEUL)
Cable One (CABO)
Lions Gate Entertainment (LGT)
Dish Networks (DISH)
AMC Networks (AMCX)
Liberty Broadband Corp (LBRDA)
Limelight Networks, Inc. (LLNW)
Liberty Braves Group (BATRA)
Pandora Media Inc. (P)
Loton Corp (LIVX)
CUR Media Inc. (CURM)
Mastercard Inc (MA)
Planet Payment (PLPM)
Vantiv Inc (VNTV)
GH Capital (GHHC)
Bazaarvoice Inc (BV)
Yelp Inc. (YELP)
G-III Apparel Group, Ltd. (GIII)
Kirkland's, Inc. (KIRK)
Differential Brands Group Inc (DFBG)
Tilly's Inc (TLYS)
Systemax Inc. (SYX)
Cabelas Inc (CAB)
Barnes & Noble (BKS)
Logitech International SA USA (LOGI)
Control4 Corp (CTRL)
Digimarc Corp (DMRC)
M o d e r nTr a d e r. c o m
were overloading the risk factors to ensure that they had
detailed anything that posed a threat. However, the process had
watered down the risk report and obscured the key risks to the
It is clear that Amazon is not just a problem for brick-andmortar retailers anymore.
Yet, while this list is quite robust, perhaps it’s more interesting
to wonder why so many companies haven’t quite taken the
responsibility to mention Amazon by name. From Sears to
Wal-Mart (WMT), from GroupOn (GRPN) to Krogers (KR),
executives aren’t addressing the threat by name.
Or perhaps they’ve chosen to just ignore it.
Perhaps that’s why one in every 10 companies during the
second-quarter earnings season received questions during
their conference call on whether Amazon posed a threat to the
company. Analysts and investors are tired of waiting for this insight.
Instead, they’re choosing to identify their enemy (see “Naming
the enemy,” left).
The “experts” are unanimous bulls on Amazon
Amazon’s View
from the Street
Q By Garrett Baldwin
According to TipRanks, 33 Wall Street analysts
rate Amazon a “strong buy” and have set a consensus
price target of $1,174.68 over the next 12 months (see “It’s
unanimous”). That represents 20.09% upside from the closing
price on Aug. 16. Most revealing about Wall Street’s bullish view
is that not a single analyst tracked on the accountability platform
has issued a “sell” position.
The most recent initiation of coverage occurred on Aug. 14 by
TipRanks analysts all rate Amazon a buy.
File: TipRanks chart
M o d e r nTr a d e r. c o m
SunTrust Robinson analyst Youssef Squali, who set a Buy rating
and a price target of $1,220. Squali is rated No. 27 out of 4,627
analysts on TipRanks. Squali has a success rate of 73% and an
average return of 19.6%.
What has him so bullish about Amazon?
While he noted that the company isn’t cheap, he argued
that the company is “fundamentally compelling” given its
domination in the ecommerce space, where it maintains
market share of 40%. As we
noted in previous coverage,
Amazon is on pace to capture
50% of that space by 2021.
Squali also cited several
other factors. “Combined
with a growing wave of
physical store closings, rise
of online private labels and
strengthening of its logistics
network, this move should
help Amazon accelerate the
pace of disruption of retail to
gain share both offline and
online,” Squali wrote in a note
to clients.
Issue 536
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L i f e , Lux u ry & t h e P u r s u i t o f H a p p i n e s s
Buying two lots:
Appreciating scotch
After The Bell has extensively documented the
phenomenal global increase in whisky consumption. This month we look
into rare Scotch whisky as a distinct alternative investment asset class.
Q By Andy Simpson
Our guide to the world of exceptional rare whiskies is Andy Simpson, the renowned scotch authority at Scotland-based
Rare Whisky 101. Andy is among the select
few to be honored with the designation
of Keeper of the Quaich — an exclusive
international society of
Scotch whisky experts.
The information that
follows appears in his
Macallan’s Grand Slam
mid-2017 report on the
European rare whisky
The Macallan virtual
secondary market and
reality experience
auction trends, which
is a reliable leading inSave your season with
these fantasy foorball
dicator for U.S. auction
As for the two lots?
Big money thinks small
at least two
bottles of desirable
whisky at a time is the
advice we consistently hear from whisky
experts. One for long-term appreciation, the
other for immediate appreciation.
portfolios (see “exotic collectibles” below).
But it has gone beyond hobbies into real
indexing. “Beating the benchmarks,”(page
50) illustrates Scotch whisky’s performance
as an alternative asset class in its own right.
Longer term, the Liv-Ex Fine Wine 100
out-performs all but scotch, while ADR
shares of British Diageo plc (DEO), the
world’s largest producer of spirits and a key
producer of beer, out-performs the broader
traditional equities market. Solid gold, as
opposed to liquid gold, comes in a close
second over the first half of 2017. However,
scotch remains at the helm from a pure
investment perspective over both the first
six months of 2017 and the longer term.
Market Overview
As the secondary market for rare
scotch continues to mature, we are seeing
increased liquidity in what was once a
relatively illiquid market. The trading costs
associated with selling rare whisky are
reducing as auctioneers compete for the
best stock. Bottles are easier than ever to
sell and prices are at all-time highs, so it
is little surprise that we are seeing such
significant increases in the number of
Lloyd’s rates the average holdings of “Passion Investments.”
Source: Lloyd’s Banking Group
Amount in USD (estimated)
Hobby Investment
or new asset class?
Evidence shows a broad–based
acceleration of interest in alternatives and
investments of passion. This was borne
out by a report by Lloyds Banking Group
in late 2016, which illustrated the average
holdings of high-net worth investors among
those that hold “hobby” investments in their
M o d e r nTr a d e r. c o m
Issue 536
This chart shows unique niche whisky & wine investments
versus traditional benchmarks.
bottles sold. Through the first half of 2017,
the market for rare whisky has experienced
unprecedented growth.
The number of bottles of Single Malt
Scotch whisky sold at auction in the UK
increased by 47.25% to 39,061. The value
of collectable bottles of Single Malt Scotch
whisky sold at auction in the UK rose by
93.66% to an all-time high. As would be
expected, the average per-bottle price has
risen to a new record of $370, up from
$282 just 12 months prior.
The Macallan’s secondary market dominance extends and it now accounts for
almost 30% of every dollar spent at auction
in the UK. The brand now has a 12.71%
share of all bottles sold and 28.90% share
of the dollar value. The incredible rise in
recent times for The Macallan 18- and
25-year-old indexes shows no sign of
slowing with the vintage 18-year-old index
adding 142.10% in value in 2016, and the
25-year-old index delivering 77.83%.
The volume of bottles of rare, desirable
whisky sold on the open UK auction market
is at an all-time high. We continue to see
online and traditional whisky retailers starting their own auctions in order to compete
in an increasingly crowded space. The days
of retailers being able to snap up private
collections at less than market value, add
on a hefty margin, and retail them are now
long gone. There appears to be seemingly
October 2017
limitless demand for and interest in the
old, rare and exclusive bottles of scotch
no longer available through traditional
retail outlets. No matter how many bottles
are sold at auction, demand continues to
outstrip supply.
Compared to the same six months last
year, the first half of 2017 has seen a near
50% increase in volumes, and a 100% increase in the value of bottles sold. For the full
year, 2017 is expected to be another record
breaker as the charts and forecasts show.
What does it mean?
In late July at the Devil’s
Place Bar in the St. Moritz Hotel,
Waldhaus Am See saw an
unnamed Chinese guest spent
$10,277 for a single glass of
Macallan 1878 vintage Scotch
Despite the labels on the darkcolored glass bottle, which state
that the whisky was distilled in
1878, and was matured for 27
years, whisky experts believe the
nearly 140 year old single-malt
bottle was fake.
The hotel has launched a full
investigation after a number of
whisky enthusiasts challenged the
bottle’s authenticity and Macallan
owner, the privately-held Edrington
Group, is assisting with the investigation. Tests are likely to analyze
the cork, glass, label and liquid
and may take up to six months.
The hotel has promised to return
the money to the guest if the liquid
proves to be counterfeit.
Scotch’s lengthy bull-run clearly looks
like it wants to continue. But speculators
should keep a close eye on a significant
dip in prices for the less desirable bottles.
In May 2012, a bottle of Glengoyne “Fly
Fishing” sold for $650. In June 2017 a bottle sold for just $60; a loss of 90.8% and
a clear reminder that selecting the wrong
bottle can be as surprising and punishing
as any illiquid investment.
We remain optimistic about scotch’s
credentials as an alternative investment,
but only, for the right bottles.
Andy Simpson is the co-founding
director of Rare Whisky 101
(, rare whisky
analysts, and brokers, and a Keeper of
the Quaich. @WhiskyInvestor
Devil’s Place bar in St. Moritz is a Mecca for
whisky lovers from around the world. With
more than 2,500 different kinds of whisky, it is
reputed to have the world’s largest collection.
M o d e r nTr a d e r. c o m
In 2014, The Macallan
accounted for the top 10 priced
bottles sold at auction.
In 2017, a new record has been
set...and it is Macallan again
Grand slam
In April, a collection of Macallan single
malt whiskies set a new world record
price for any lot of whisky sold at auction,
selling for more than $993,000.
The Macallan in Lalique Six Pillars
Series – The Legacy Collection, a set of
six stunning crystal decanters containing
the rarest of The Macallan’s single malts
aged from 50 to 65 years old, complete
with an ebony cabinet from Lalique – was
auctioned by Sotheby’s in Hong Kong.
The winning bid by an unnamed buyer
almost doubled the pre-auction estimate
for the lot, which was predicted to sell
between $260,000 to $500,000. The lot
was sourced direct from the distillery.
Housed in a bespoke natural ebony
cabinet created by Lalique Maison, the
Legacy Collection also holds six Macallan Fine and Rare miniatures; two from
each of the 1937, 1938 and 1939 vintages (signifying the zenith of Lalique’s contribution in the French Art Deco period),
and six pairs of Lalique Macallan glasses,
each serial numbered to commemorate
the unique partnership. Autographs of
the masters behind the collection are
also included inside the cabinet and allow for the buyer to have their own name
M o d e r nTr a d e r. c o m
engraved within it as well.
Since its inception in 2005, The
Macallan in Lalique Six Pillars series has
captured the imagination of collectors
around the world. In 2014, The Macallan
accounted for the top 10 priced bottles
sold at auction; eight out of 10 sales
being decanters from The Macallan in
Lalique series. In 2015, The Macallan
was the most valuable whisky brand at
auction, accounting for more than 25%
of the total value traded at auction.
Issue 536
The Macallan virtual reality
experience cocktail
I don’t need an excuse to enjoy rare
scotch whiskies, but news that The
Macallan and Baptiste & Bottle, a bar
located in the Conrad Chicago, had
joined forces to create a virtual reality
cocktail experience provided some
intriguing editorial cover. So, I rang
up David Sweet, long-time operator
of the Whisky Live (
tasting events around the country, and
our go-to whisky resource, to join me
to be among the first to experience
the recently-developed The Macallan
Rare Journey — a technology-infused
cocktail that takes guests on a multisensory journey via a virtual reality
The $95 cocktail features The
Macallan Rare Cask, aged in the
top 1% of all casks maturing at The
Macallan distillery. The finished
cocktail is a marriage of Bodegas
Tradicion 30-year Oloroso Sherry and
The Macallan Rare Cask.
Raquel Raies, The Macallan’s
first female National Ambassador
conceived of this unique cocktail
experience. Raquel personally walked
Dave and I through each step of the
immersive cocktail featuring a mossladen box, a curious acorn, dry ice and
three empty glasses.
As Raquel talked us through the
“acorn to bottle” distillation process
and The Macallan story, we learn that
the distiller owns nine out of 10 sherry
casks in the world. The casks used
to make Rare Cask come from sherry
houses that no longer exist, which is
one of the reasons why Rare Cask
retails for nearly $300 a bottle; and
that this is such a rare experience.
Rare Cask’s rich ruby-red whisky
celebrates three of The Macallan’s
greatest prides: Exceptional sherryseasoned oak casks, rich flavor and
beautiful natural color. The interaction
of spirit and wood alone delivers the
October 2017
beautiful range of vibrant natural colors
and flavor complexities that distinguish
The Macallan whiskies; these signature
characteristics reinforce the brand’s
position as one of the world’s truly
great single malt whiskies.
Ultimately, we put on the virtual
reality goggles and fly through
vineyards to sherry bodegas and end
at the Macallan distillery and Easter
Elchies house, the spiritual home
that appears on every bottle of The
By the time the virtual trip is done,
the cocktail is waiting for the guest to
enjoy, along with side cars of Sherry
and Rare Cask to sip on individually.
This allows the guest to see how each
spirit tastes on its own as well as
As for the VR cocktail experience?
Dave declared it “a unique and
intriguing tasting experience that
utilizes all of the senses to explain the
history and craftsmanship that goes
into producing special select bottlings
of Macallan,” adding that it enhanced
his appreciation for the intricate detail
behind the brand.
As for the Rare Cask, it’s very dark
red for a scotch. The scent is rich with
dark cherry, raisins, cocoa and a whiff
of citrus. The sherry, chocolate and
apricot nectar flavors are immediately
apparent. The finish is elegant.
The entire Rare Journey cocktail
experience is certainly unique and
engaging. But in the end, it is all
about the Macallan Rare Cask, which
is exquisite all on its own. The $95
cocktail was fun, and we find a two-lot
purchase of Rare Cask by the bottle to
be the more prudent trade.
Photos top to bottom: Raquel Raies, National
Brand Ambassador for the Macallan; Drink
menu at Chicago Conrad’s Baptiste & Bottle;
The Macallan Rare Journey VR Cocktail
M o d e r nTr a d e r. c o m
Save your season
with these fantasy
football picks
Q By Garrett Baldwin
With NFL season on the horizon, it’s time to take a look at our Fantasy Football value picks.
Last year, we nailed it on Drew Brees, Jordan Howard, Frank Gore and
Dwayne Allen. We missed pretty badly on Duke Johnson, Demaryius Thomas,
Mohammed Sanu and Eli Manning.
But fantasy football is all about value. Get half of your final eight picks right,
and you’re looking at a team capable of making a run to the championship.
This year, we’re looking again at 16 players who might save your season.
The high upside picks
Ben Roethlisberger: You’ll probably
only want to start him at home. But when
he’s playing in Pittsburgh, watch out. The
addition of Martavis Bryant makes this a
top three offense in the NFL.
Matthew Stafford: It seems like
everyone hates this guy, but with a
questionable run attack in a conference
that is stacked with good offenses, the
Lions will live and die by Stafford’s arm.
He’s a great player to draft and pair with
another quarterback that has solid games
on the docket. Phil Rivers and Andy Dalton
come to mind.
Running back
Derrick Henry: He’s going mid-7th
round. I’m taking him at 66th overall. If
Demarco Murray gets hurt, you’re looking
at a top-five back. If Demarco Murray gets
hurt, you’re looking at a top 25 back, which
is fair value in the previous round.
Joe Mixon: If the Cincinnati Bengals
stop with the loyalty to veterans
(another way of hurting your team and
guaranteeing poor outcomes), then
Mixon will get 18 to 22 touches per
game and run away with rookie-of-theyear honors and have numbers close to
Adrian Peterson’s rookie year.
October 2017
Wide receiver
Jarvis Landry: The loss of Tannehill
is going to curb the expectations for
Devante Parker. Jay Cutler throws the ball
to possession receivers. Jarvis Landry
moves the chains...and the Dolphins will
be throwing a lot if Cutler is there ruining
everyone’s dreams in Miami.
Jeremy Maclin: Possession receivers in
the slot receive lots of targets. Maclin will
lead Baltimore receivers in catches and
yards. Yet, people are valuing him and his
teammates the same. This is a number four
receiver who will offer number two value.
Tight end
Rob Gronkowski/Coby Fleener: This
is the year to take Rob Gronkowski. For
a TE, you’re looking at about 168 points
on the year (assuming he stays healthy)
in the early third round. That is better than
all but eight wide receivers (and there is a
lot of uncertainty between after you pass
through the top 10 receivers). If you’re
drafting Gronk, you’ll need insurance. That
can be found late with Coby Fleener as a
bounce back candidate.
to double down. This year, Manning has
a shaky running game behind him, and
four outstanding receiving threats in Odell
Beckham Jr., Brandon Marshall, Sterling
Shepherd, and tight end Evan Engram.
Tyrod Taylor: A top-eight quarterback
going number 16th overall in drafts.
Running back
Jonathan Williams: Mike Gillislee
did wonders in Buffalo last year as
LeSean McCoy’s backup. Williams is
better, and Buffalo is going to run the
ball. He is a great value in touchdownonly leagues where points are a
premium. Ten touchdowns are possible
by the end of the year.
Alvin Kamera: Remember when Darren
Sproles played for the Saints and broke off
60-yard screen passes? It will be similar
this year.
Wide receiver
Randall Cobb: Wide receiver is so
deep and uncertain that a guy who was
borderline top 12 in 2015 is sitting at a
consensus 44 this year. Do people think
that Jordy Nelson and Devante Adams are
going to catch everything? Cobb is healthy
again, and he’ll be all over the field.
Eric Decker: He’s the number one
receiver in Tennessee, he has a better
quarterback in Mariotta than he did in New
York, and he is the team’s only red zone
threat. Great value.
Tight End
Fantasy sleepers for
late in your draft:
Eli Manning: Sometimes you just have
Julius Thomas: This is a scheme play.
Adam Gase made Thomas a star in Denver,
and Jay Cutler made Martellus Bennett a
star in Chicago in 2014. Thomas can play,
M o d e r nTr a d e r. c o m
(Top)Rob Gronkowski.
(Bottom) Ben Roethlisberger.
and Gase will make sure he’s open with
Parker taking the top off the defense.
Austin Hooper: Upstart and stillunknown Atlanta Austin Hooper is a guy
with a lot of upside. If you’re going to take
a tight end early, remember that Kelce,
Gronk and Reed have injury risk. So, be
sure to reach for a guy who can finish the
year in the top 10 and not cost you dearly
this season.
Buyer beware:
(Top) Disney, ABC Television Group. (Bottom) Keith Allison.
Check the average
draft position before
you pick these players
• Round 1: Jordan Howard. Last
year, he was a deep value. This year, he’s
going in the first round of drafts ahead
of Demarco Murray and Todd Gurley.
Howard is the center of the Chicago
offense, but the Chicago Bears are a
very bad team, that could abandon the
run very early.
• Round 2: Leonard Fournette:
Someone in your draft is going to take
him early, but this is not the same player
as Ezekiel Elliott and the Jaguars are
not the Cowboys. Take Isaiah Crowell
or Lamar Miller instead given their more
stable floors.
• Round 3: Brandin Cooks: You have
to believe he is the second coming of
Randy Moss, but this passing game will
still run through Gronkowski this year.
Cooks is more of a low-end #2 who will
have boom or bust weeks. Not what I
want in a number one receiver, but take
at a price.
• Round 4: Allen Robinson: He’s a
rebound candidate, but you have to trust
Blake Bortles. No reasonable person
trusts Blake Bortles, not even his parents.
M o d e r nTr a d e r. c o m
• Round 5: Ameer Abdullah: The
hype train is heavy with this one, as
Abdullah is getting a lot of love in
preseason drafts.
• Round 6: Kelvin Benjamin: The
addition of Christian McCaffrey makes
him a risky proposition.
• Round 7: Emmanuel Sanders:
Is Paxton Lynch really going to be the
quarterback this year?
• Round 8: Rob Kelley: Avoid
Washington running backs not named
Samaje Perine.
• Round 9: Jamaal Charles: His
knees scare us. Why take him when
John Brown is available?
• Round 10: Houston Defense:
The second defense usually comes off
the board in the 10th round. Meanwhile,
Corey Coleman will still be available,
and the depth you get right here for a
bye week is critical.
• Round 11: Kenny Britt: Can
you name the starting quarterback
of Cleveland? If not, you should be
looking at bounce back candidate
Marvin Jones or rookie speedster
Zay Jones.
• Round 12: Kenneth Dixon: This is
cheating, but it’s also a reminder that
Dixon is out for the season due to knee
surgery. That said, if you’re setting up
on auto draft, make sure you remove
him from your late round selections.
• Round 13: Stephen Gostkowski:
This is right around the place where we
start to see a kicker run. Meanwhile,
Jonathan Williams in Buffalo, Ted Ginn
in New Orleans, or super-handcuff
Darren McFadden are waiting to help
teams build depth. Personally, I don’t
even draft a kicker in a live draft.
• Round 14: Blake Bortles: Thou
shall not draft Blake Bortles.
Issue 536
Book Value
Big Money
Thinks Small:
Biases, Blind Spots,
and Smarter Investing
By Joel Tillinghast
Columbia University Press
Published: August 2017
312 pages
Format: Hardcover & e-book
List price: $29.95 (£24.95)
Do not invest emotionally using your “gut”; Do
invest patiently and rationally.
Do not invest in things you don’t understand,
using knowledge you don’t have; Do invest in
what you know.
Do not invest with crooks or idiots; Do invest
with capable, honest managers.
Do not invest in faddish or fast-changing,
commoditized businesses with a lot of debt; Do
invest in resilient businesses with a niche and
strong balance sheet.
Do not invest in red-hot “story” stocks; Do
invest in bargain-priced stocks.
Thirty-six-year veteran fund manager Joel Tillinghast shows
investors successful stock market investing in this informative
One of the most persuasive tips Tillinghast offers is to only
invest in businesses that you understand, which explains how an
obscure economist came to launch the market-beating Fidelity
Low-Priced Stock fund nearly 28 years ago.
Tillinghast explains how the best investment risks are those that
you can analyze and that offer favorable odds. Unless you have
taken the time to understand the details, complexity is your enemy.
Big Money Thinks Small points out that some investors may
develop a false sense of confidence after reaping large profits on
luck bets. More often than not high-stakes gambles backfire, not
only hitting you in the balance sheet but also taking a mental and
emotional toll.
To remain emotionally focused in such a volatile profession,
Tillinghast provides a very useful checklist written for investors at
all levels. These principles can be seen as a useful list of do’s and
This practical, no-nonsense guide doesn’t reveal specifics on
where to invest, but it does speak to the value of human judgment,
so you can generate your own informed choices.
Tillinghast urges investors to act cautiously and follow primary
steps to successful investing and he provides tables and figures to
give a psychological breakdown of traits of successful investing.
He also addresses relevant questions including how to
anticipate market changes. Tillinghast explains how to be patient,
self-aware and how to plan methodically, which will pay far greater
dividends than flashy investments.
In Big Money Thinks Small, some discussions are fairly basic;
such as how to select trustworthy money managers; but other are
more robust points, such as how to value stock properly.
Tillinghast teaches readers how to learn from their mistakes and
his own: He stresses avoiding emotional decisions, investments
that you don’t understand well, bad people and unstable business.
While most of these lessons are pretty basic, it doesn’t hurt to be
reminded of them because it only takes one bad decision to lose
a fortune.
Big Money Thinks Small explores the tools investors need to
ask the right questions in any situation and feel empowered to
think objectively and accordingly about portfolio management.
--By Tamarah Webb
“Do not invest
using your ‘gut’;
Do invest patiently
and rationally.”
October 2017
M o d e r nTr a d e r. c o m
CQG trading
2 Live price
monitoring via
3 Live portfolio
4 Development
of new
Irene Perdomo:
and principal
Firm: Devet Capital
Investments Limited
Strategy: Systematic market
neutral (commodities)
Location: London
AIF 2016
If at first you don’t succeed …
throughout the year, according to BI. MRA specialized in
analyzing global market risk and executing transactions on
behalf of institutional investors, according to its website.
Business Insider reported in April that “50-cent” had already
racked up $89 million in losses in the hope of a spike in the
VIX. Those losses grew to $150 million prior to the recent
winner. Apparently, the moniker
is in reference to the size of
the bets he makes. Business
Insider noted that the trader’s
“50-cent’s” losses grew to $150 million prior to its recent losses
in the hope of a spike in the VIX.
identity has been traced by the
Source: eSignal
Financial Times to Ruffer LLP,
a $20 billion London-based
investment management firm.
According to the story, “50cent” is reinvesting the recent
profits into more long out-of-themoney VIX calls.
Business Insider has been reporting on the unusual trading
activity of a mystery trader who placed a profitable short
equity bet to the tune of $21 million on the Aug. 10 move in
the CBOE Volatility Index (VIX). The trader dubbed “50cent” by independent broker-dealer Macro Risk Advisors
(MRA) has made a series of unsuccessful volatility bets
M o d e r nTr a d e r. c o m
Issue 536
The Past 12 Months of MODERN TRADER…
The Trouble with Restaurant Stocks
Inside our meatiest issue ever
Feature Stories: Our look at the sector’s risk factors and the new automation technologies that will fuel further growth included a
never before published short-trade thesis on restaurant stocks developed by hedge fund research portal, Senteio, an interview with
former McDonald’s CER Ed Rensi on the sector’s challenges and hopes, the restaurant sector’s MENU index ETF, what cattle futures
are telling us about higher beef prices and more than 40 restaurant stock picks and pans.
Special Reports Included: A profile of a volatility trader with a successful 20-year track record, Golden Brackets: Strangles
Provide Sizeable Yield, ABC: Symmetry, Harmonics & Patterns, Trading the Locomotive Breakout, Renko Bricks, Our 11 Favorite
Assets That We Will Never Trade Away, The Morton Steak House Legacy, Five Favorite Mail Order Meats, New Book, Music & Media
Reviews and our guest editorial calling out the folly of a mandated federal minimum wage increase.
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Essential, time-tested trading strategies
Options can be simple tools or
extremely complex tools depending on your goals.
Here we start at the beginning.
Options Basics
Q By: Michael Thomsett
expiration month. The last trading day is the third Friday. After an
Many stock traders have heard of options but do not really
option’s expiration, it ceases to exist and becomes worthless.
understand them. Others assume they are complex and high-risk.
This does not always have to be true, as many forms of options are
• Strike price: The strike price is the fixed price at which
conservative and straightforward.
exercise will occur. So, an option with a strike at 25 will be
A major hurdle to developing a working
exercised at $25 per share.
knowledge of options is terminology. The options
To properly describe an option, you need to clarify
industry is full of exotic terms and phrases; this not
all four of these terms. “An option’s components”
only confuses outsiders but discourages them. So
(right) shows a listing with all terms spelled out: the
here is an attempt to explain the basics, if only to
underlying McDonald’s (MCD), expiration month,
Trading Bearish
provide a starting point.
day and year, strike price and type of option (in this
Shark Patterns
An option has no tangible value; it’s a contract
case, a call).
that grants its owner specific rights. Every option
The option is highly leveraged, averaging between
Trading Social Media
has four standardized terms that distinguish one
and 5% of the price of 100 shares of the
Sentiment Indicators
option from another. These cannot be transferred or
underlying stock. But because it will expire by a
changed. They are:
specified date, the value of the option (known as its
Summer Weather
premium) tends to decline as expiration gets closer.
• Underlying security (or asset): All options are
Premium Pump
An option buyer can never lose more money than the
written on a specific underlying security (a stock,
cost of the option, so risk is limited to the value at
index, ETF or futures contract). This can never
The Bonus Trade
the time of purchase.
be changed. So as part of identifying an option,
Options can also be sold. A seller grants all
the underlying security also has to be defined.
Trading Weatherof
the rights of exercise to a buyer, including
• Type of option: There are two types of options.
driven Grain Markets
risk that an option can be exercised. In that
A call grants its owner the right—but not the
case, option sellers will have 100 shares called
obligation—to buy the underlying asset (100
away (through selling a call) or will have 100
shares of stock in the case of a security). A put
shares put to them (by selling a put).
grants its owner the right—but not the obligation—to sell the
It is important to keep in mind the following points about options:
underlying asset or security.
1. The rights granted through an option to buy or sell, are never
• Expiration date: All options expire on a specific date.
infinite. Expiration is a fact of life in options trading.
For monthly equity options, that is the third Saturday of the
M o d e r nTr a d e r. c o m
Issue 536
“An option has no
tangible value; it’s a
contract that grants
its owner specific
2. Terms can never be exchanged
with other terms; they are fixed and
3. The most common form of listed option applies to 100 shares of stock.
An easy method to keep different options
and positions in mind is to check the following
four-part list describing the four possible simple types of trades, which are as follows:
1. Buy a call (buy the right to buy 100
2. Sell a call (sell to someone else the
right to buy 100 shares from you).
3. Buy a put (buy the right to sell 100
4. Sell a put (sell to someone else the
right to sell 100 shares to you).
Directional ideas also define whether
to buy or sell, and whether to use
calls or puts. “Matching trades” (right)
summarizes how this works.
Know your Greeks
Another consideration for how options can
be valued is through a series of factors
known as the “Greeks.” The first of these
is Delta. Calls have positive Delta between
0 and 1, and puts have negative Delta
between 0 and -1. Delta represents the
level of price move in an option you expect
to see, based on changes in the underlying.
If the underlying moves one point, you
expect it to move point for point with the
underlying. A 0.50 Delta means you expect
a 50¢ move for every $1 of movement in
the underlying price.
The second Greek is called Gamma. This
is the rate of Delta‘s speed of movement.
It is the momentum (or acceleration) of the
Delta. High Gamma implies a high level of
responsiveness by an option to movement
in the underlying.
A third Greek is Theta, which measures
“An option buyer can never lose
more money than the cost of the
option, so risk is limited to the
value at the time of purchase.”
October 2017
time decay. As expiration approaches,
the rate of time decay in the premium of
the option increases. Theta measures the
degree of price change in the option for an
equal move in the same time period by the
underlying. Theta is going to be different for
at-the-money options (when the strike price
is at or near the current price per share) than
for in-the-money or out-of-the-money options.
This “moneyness” measures the distance
between underlying price and strike.
Vega, a fourth Greek, defines change in
call or put premium value for each change
in volatility. The volatility is an estimate of
how much movement you will see in the
option over time and based on a series of
assumptions based on current conditions
in the underlying and in the option itself.
It is extremely important to understand the
Greeks before you begin trading options.
The Chicago Board Options
Exchange (CBOE) provides a free
calculator (
calculators), which performs the various
calculations of the Greeks.
To anyone new to options, what constitutes
long and short positions can be confusing.
Following is a table that explains it.
M o d e r nTr a d e r. c o m
A long call or short put is equivalent to a long
position in the underlying, and vice versa.
Call buyer
Call seller
Put buyer
Put seller
in Price
in Price
A difficult aspect to options trading
is in understanding the differences
between long and short. A long option
is a buy of either a call or a put. A long
trader buys the option as a first step and
closes it later.
A short option is a sell position. In this
case, the first step is a “sell to open” and
the last step is a “buy to close,” so the
sequence of events is reversed: sell, hold
and buy. With these distinctions in mind,
the question remains: Are options always
Some types of options trading are highrisk. Selling calls, for example, without
also owning shares of stock, is a “naked”
trade and could lead to significant losses.
But on the other side of the risk spectrum,
selling a call when you also own 100
shares of stock is a very conservative
trade. It generates income, but you still
M o d e r nTr a d e r. c o m
earn a dividend as well. This “covered”
call eliminates the risk of a short sale. In
the event of exercise, you are required to
deliver 100 shares at the current price.
Having those shares on hand makes this
an easy final step. And if the strike of the
covered call was higher than your original
cost per share, you also get a capital gain
on the stock.
In between the uncovered or naked call
and the covered call is broad range of trades.
These run the full range from high-risk to
extremely conservative. So the two overall
rules about options are: Learn the terminology
and trading rules, and understand the true
risk level before making a trade.
An excellent way to learn about options
trading without putting money at risk is
to “paper trade” first. This is a system of
trading in an artificial or “virtual” portfolio
that behaves exactly like the real thing; but
no money is placed at risk.
Many exchanges, brokerages and
trading platforms offer paper trading.
Once you learn the basics, you need
to decide for what purpose you will trade
options. Options can be used to take
directional bets on an underlying market,
“It is extremely
important to
understand the
Greeks before
you begin trading
as a risk management tool or as a bet on
movement in volatility. The great benefit of
options over trading an underlying security
or futures contract is that you can define
your risk and make a much more precise
trade. When buying an option, whether as
a directional play or for risk management
purposes, you only risk the premium you
pay. Selling naked options entails more
risk, but not any greater risk (other than
leverage) than in an outright position in an
underlying security or futures contract.
When using options it is best to first
define what you are trying to accomplish.
Are you making a directional bet? Are
you hedging an existing position? Are
you looking to benefit from an expected
spike in volatility? Once you know that
and have an understanding of the Greeks
so you know where to expect prices to
move based on the movement of the
underlying, you can decide on which
options tools to use.
Michael Thomsett is author of 11
options books and has been trading
options for 35 years. Thomsettpublishing.
com @michaelthomsett
Issue 536
Applying classic chart
patterns to current
trading opportunities
Below are the component stocks in the
Dow Jones Transportation Average.
Alaska Air Group Inc
C.H. Robinson Worldwide Inc.
Cirrus Networks Holdings Ltd.
CSX Corp.
Delta Air Lines Inc
Expeditors International of
Washington Inc.
FedEx Corp.
GATX Corp.
J.B. Hunt Transport Services
JetBlue Airways Corp.
Kansas City Southern
Kirby Corp.
Landstar System Inc.
Matson Inc.
Norfolk Southern Corp.
Ryder System Inc.
Southwest Airlines Co.
Union Pacific Corp
United Continental Holdings
United Parcel Service Inc.
Q By: Suri Duddella
The modern world has seen plenty of
disruptions in its path of modernization.
Disruptive innovations are necessary
along with new technologies and new
entrants to provide faster and more efficient
technologies, methods and services going
forward. The past disruptive technologies
include the Sony Walkman, Minicomputers,
increased computer storage, iPods, the
Kindle, the iPhone and much more. The
world should look at these disruptive
technologies as a positive force to make
products and services easily accessible
and affordable for the masses.
Amazon (AMZN) has been at the forefront of disruptive technologies since 1999,
as it is changing how people interact, eat,
work, shop, dress and travel. Amazon’s big
attraction for consumers is its low prices
with free shipping. Amazon achieves this
ultra edge of affordable low price and
convenience through high-tech innovations,
superior supply-chain management and
its fulfillment network. A secular shift in
consumer behavior with Amazon’s technological innovative ideas has given Amazon
a stronghold in e-Commerce and retail
sectors. Their recent acquisition of Whole
Foods Market (WFM) is an example of
grocery disruption. But it has also created
major disruptions in the cloud services,
retail and transportation sectors.
In 2013, Amazon’s CEO Jeff Bezos
introduced the world to its futuristic delivery
plan of using drones. With drones and
self-driving trucks, disruption is headed
for transportation. Amazon is preparing
its transportation disruption using cutting-edge technologies, innovative logistics
and massive fulfillment networks.
Technology disruptions affect industries
across all sectors. Drones and self-driving
trucks will affect the transportation sector
along with the trucking, insurance, con-
“Drones and self-driving
trucks will affect the transportation
sector along with the trucking,
insurance, construction, auto
parts and hotel sectors.”
October 2017
Source: CNBC
struction, auto parts and hotel sectors. The
Dow Jones Transportation Average
(DJTA), also known as the Dow Jones
Transports, is made up of airlines, railroads
and trucking companies. The DJTA is
the oldest U.S. stock index, compiled by
Charles Dow, co-founder of Dow Jones
& Company, and dates back before the
Dow Jones Industrial Average. This index
consists of airlines, railroads, trucking; and
delivery services and marine transportation
stocks (see “Team Transpoports,” above).
Here, we will present a five-point
Harmonic pattern formation (Bearish Shark)
in the DJTA ($TRAN) and how to trade it.
5-Point Harmonic Patterns
The foundation and trading concepts of
Harmonic patterns were introduced by
H.M. Gartley in 1932. Gartley wrote about
a five-point pattern (known as Gartley) in
his book, Profits in the Stock Market. Few
other authors have worked on this pattern
M o d e r nTr a d e r. c o m
Below are examples of the Gartley bull and Gartley bear five-point Harmonic
Source: SuriNotes
and its symmetry in markets. Fibonacci
ratio analysis works well with any markets
and on any time frame. The basic idea of
using these ratios is to identify key turning
points, retracements and extensions along
with a series of market swings. The derived
projections and retracements using these
swing points will give key price levels for
price targets or stops.
Pattern Identification
theory. The best works have come from
Scott Carney in his books on Harmonic
Trading. Carney also discovered patterns:
Crab, Bat, Shark and 5-0; and added depth
of knowledge with Fibonacci ratios and established trading rules to improve risk and
M o d e r nTr a d e r. c o m
money management. His pioneering work is
impressive, and has opened newer trading
styles and careers for many traders.
The primary theory behind Harmonic
patterns is price/time movements, which
adhere to Fibonacci ratio relationships
Harmonic pattern identification can be a bit
hard with the naked eye, but once a trader
understands the pattern structure, it can be
relatively easily spotted by Fibonacci tools.
The primary harmonic patterns have fivepoints: Gartley, Butterfly, Crab, Bat, Shark
and Cypher patterns. These patterns have
embedded three-point (ABC) patterns and
four-point (ABCD) patterns. All the price
swings between these points are interrelated and have harmonic ratios based on
Fibonacci. Patterns are either forming or
completed “M” or “W-shaped” structures,
or combinations of “M” and “W” in the case
of three-drives. Harmonic patterns (fivepoints) have a critical origin (X) followed
by an impulse wave (XA) followed by a
corrective wave to form the “EYE” at (B),
completing the AB leg (see “Gartley bulls &
bears,” left).
Then, this is followed by a trend wave
(BC) and finally completed by a corrective
leg (CD). The critical harmonic ratios
between these legs determine whether
a pattern is a retracement based or
extension based pattern and defines its
names: Gartley, Butterfly, Crab, Bat, Shark
and Cypher. One of the significant points
to remember is that all five-point and fourpoint harmonic patterns have embedded
ABC (three-point) patterns.
All five-point harmonic patterns have
similar principles and structures, and they
differ by their ratios to identify them and
locations of key nodes: X, A, B, C, D; but
once one of the patterns is understood, it
may be relatively easy to grasp knowledge
of others. It may be helpful for traders to
Issue 536
A short signal in for the Bearish Shark Pattern was initiated on July 18.
By Aug. 1, $TRAN was approaching the first profit target.
Source: SuriNotes
action point D. The projections are computed using Fibonacci ratios like 62%, 78.6%
of XA leg and added to the action point
(D). The extension ratios—1, 1.27, 1.62,
2, 2.27, 2.62—are computed for potential
target levels. The primary target zones
are marked computed from D as 62% to
78.6% of the XA leg (or largest of XA and
CD) as the first target zone and 127% to
162% as the second target zone.
Target Zone1: (D + XA*0.62) to
Target Zone2: (D + XA*1.27) to
Shark Engaged
use an automated pattern recognition
software to identify these patterns rather
than relying on the naked eye, which could
produce false positive signals.
Trade Entries and Stops
The most effective trades in these five-point
patterns are reversal price-action ones
combined with a reversal trend change
from the reversal zones at point “D.” It could
be a bullish pattern or a bearish pattern.
Usually, “D” is identified by a confluence of
projections, retracements and extensions
of prior swings (legs), universally called
a reversal zone. The entry criteria and
pattern validity are determined by various
other factors like volatility, underlying trend,
volume structure within the pattern and
market internals. If the pattern is valid and
the underlying trend and market internals
agree with the harmonic pattern reversal,
then entry levels (EL) can be calculated
using price-ranges, volatility or some combination. Stops are placed above/below the
last significant pivot (in five- and four-point
patterns it is below D for the bullish pattern,
above D for bearish patterns).
Target Zones
Target zones in harmonic patterns are
computed based on the retracement, extensions or projections of impulse corrective
swings and Fibonacci ratios from the action
point of the pattern structure. For example,
in Gartley’s bullish pattern, the target zones
are computed using XA leg from the trade
“The primary theory behind
harmonic patterns is price/time
movements, which adhere to
Fibonacci ratio relationships and its
symmetry in markets.”
October 2017
The following example shows an auto-generated Bearish Shark (five-point) pattern
formation in the DJTA (see “Transport
short,” left).
After a steep rise in $TRAN from January
2016 to June 2017, prices may have formed
a top as it builds a Bearish Shark pattern.
The Bearish Shark pattern is a variation of
the Gartley pattern with different retracement and extension ratios. A Bearish Shark
pattern formed after extending beyond both
point X and point A. Point “B” also formed
at a critical 61.8% XA level.
How to it trade it.
1. A potential completion zone is
formed in a cluster around 9600 to
9800. This indicates a Bearish Shark
pattern is complete with an entry
level (EL) below 9661.
2. On July 18, 2017, $TRAN closed
below the entry level (EL) to trigger a
short trade at 9661.
3. A stop is placed above point D at
4. The first target zone is set at 89629133. The second target zone is set
at 8112-8469.
Suri Duddella is a 20-year veteran
pattern-based, algorithmic trader and
author of Trade Chart Patterns Like the
Pros. @tradepatterns
M o d e r nTr a d e r. c o m
Short-term social media
sentiment analysis can help
improve trading systems
Trading Social
Media Sentiment
Q By: Philipe Saroyan
With the growing popularity of social
media and its induction into investment
and trading metrics, there is a growing
interest in studying it’s ability to predict
market movement. Here, we review prior
research and attempt to answer the
question of whether or not it can be a valid
predictor of stock and currency returns.
In seminal research from University of
Pennsylvania Professor Philip Tetlock,
there is a distinguishing factor between
sentiment and information given news or
media release. New news, or information,
such as earnings and/or economic
developments, has permanent effects
on stock returns. This is opposite to the
so-called sentiment effects given news,
where the media may just be repeating
themselves with news that has already
been put out in the public domain. This
is what’s called a media effect, and it
does still have an impression on stock
returns; but only temporarily. The major
point of his sentiment research is that
negative news, which is new information,
can cause greater risk-adjusted returns
in stocks, up to one quarter after the
release. The research also shows that
stock returns were quickly reversed with
so-called sentiment effects from news.
In this case, the focus is on social
media quantified by the five-day raw
score gathered from Social Market
Analytics (SMA). The raw score is an
unweighted, unbiased statistic of social
media from Twitter and StockTwits. This
is our proxy for the so-called Social
Media Factor (SMF), which can filter real
news and information, as well as what
is pure sentiment. When the five-day
raw score is positive, it will generate a
buy signal, and when the five-day raw
score is negative, it generates a sell
signal. Because this requires some
sophisticated text analytics via computer
coding, the best way to replicate this
SMF indicator is to either license
This flow chart on sentiment analysis goes through all of the factors and
variables that can be a cause and effect to a stock’s price return.
“When the NAV
price is at a
discount to the
previous day’s
average price,
this creates a sell
M o d e r nTr a d e r. c o m
Issue 536
the data through SMA, or to gather
some end-of-day data from similar data
Data & Methodology
One possible way to emulate the five-day
raw score is to simply compile data from
Sentdex online and take a five-day moving
average of its data on the spot euro.
Sentdex provides multiple sentiment
indicators for different markets and
trading instruments. The company, also
in the explanation of the data, shows
the difference between keyword usage
and weighting versus a neuro-linguistic
programming (NLP) method.
The data from SMA uses a proprietary
NLP algorithm, which weights and
synthesizes data from StockTwits and
Twitter. This is important to understand
because the source of the data is
purely from social media. This would
be our best proxy for sentiment with
regard to a SMF, which is expounded
in prevailing research. The Sentdex
source on the other hand, will generate
an indicator from news sources, which
is also relevant, but more a proxy for the
sentiment given news as described, and
illustrated in “How it works” (page 65).
“The sentiment
trader should
be ready to
take profits
when the OSI is
outperforming the
five-day raw score.”
October 2017
An alternative method is to test sample
data from Accern for free via Quantopian.
That company provides a sample set
of news sentiment scores on the entire
stock universe for the period of August
2012 to February 2014.
Proprietary Sentiment
One of the baseline indicators the
Options Sentiment Indicator (OSI) is our
noise trading indicator calculated and
summed up using total open interest of
underlying options. For this dataset, we
use the Euro ETF (FXE). It differs from
traditional put-call ratios in that it is able
to explain all option buying and option
writing activity; whereas, traditionally, a
put-call ratio can only explain the buying
activity, without accounting for positions
that were sold to open.
The indicator generates a buy signal
when there is net call buying and net put
writing; effectively a synthetic long futures
contract bought by the collective market.
And, it generates a sell signal when there
is net put buying and net call writing,
equivalent to a synthetic short futures
contract. The calculation can be seen later
on in this article.
Backtested Strategy
“Keeping score” (below) summarizes the
portfolio statistics for each sentiment
trading strategy on the euro. The backtest
period is from May 2014 to May 2016.
Notice the five-day Raw Score indicator,
it has the best risk-adjusted performance
of all the data sets.
“Taking the next step” (right) shows the
portfolio statistics when incorporating
an added sentiment indicator based on
whether the ETF’s Net Asset Value (NAV)
is trading at a premium or discount. This is
an additional sentiment trading indicator
called the Closed-End-Fund Discount
(CEFD) indicator, which is ideal for
discounting sentiment as a trading tactic.
For the CEFD indicator to generate a
buy signal, the NAV should be trading
at a premium from the previous day’s
average price; this confirms a buy signal
for the CEFD indicator. When the NAV
price is at a discount to the previous
day’s average price, this creates a sell
signal. The indicator’s formula is:
This indicator is contrarian, opposite
the other two indicators, which are
Summary portfolio statistics results.
5-Day Raw Score 477
Euro ETF
OSI + 5-Day Raw 86
M o d e r nTr a d e r. c o m
Portfolio Statistics with CEFD indicator.
Source: sourcegoeshere
Euro ETF
5-Day Raw Score +
CEFD Indicator
CEFD Indicator
OSI + CEFD Indicator 175
coinciding indicators. Notice in the
results from “Taking the next step” that
the risk-adjusted performance for all
the data sets are pretty much the same,
except for the Euro ETF, which exceeds
the five-day raw score + CEFD indicator.
Differentiating Sentiment
Because the five-day raw score and OSI
are non-correlated (-0.019 correlation)
they are useful in gauging sentiment for
the tactical trader.
One way to look at this is that the
performance from your proxy for the
SMF is your main sentiment equity line;
any extra profitability coming from the
coinciding OSI is simply noise, which
should be a reason for profit taking.
In other words, when backtesting
and tracking the performance of both
indicators, whenever the OSI touches or
crosses over the five-day raw score, that
means most of your profits from trading
sentiment is noise. With that said, the
sentiment trader should be ready to take
profits when the OSI is outperforming the
five-day raw score (Social Media Factor).
The five-day raw score indicator has
a positive correlation (0.4) with the
underlying FXE. The greater this number,
M o d e r nTr a d e r. c o m
the stronger tendency for prices to be
correlated with sentiment. This also gives
rise to a contrarian viewpoint. If raw
score were to reach an extreme, chances
are the prices have topped, with a near
perfect correlation.
In this case, the correlation is
moderately positive. Yet the correlation
for OSI is slightly negative, making it
ideal to implement as a coinciding—as
opposed to a contrarian—indicator. With
that said, we would expect the two
indicators to repel each other anytime
they were to come close, where the OSI
shouldn’t be outperforming the five-day
raw score with regard to sentiment, all
things remaining equal.
In the flow chart, you will notice
the expressions, “information given
news” and “sentiment given news.” It’s
important to note that the former can be
construed as a leading indicator, where
the latter is more of a lagging indicator.
Sentiment given news does not produce
sustainable excess returns and adds no
real information that can be discounted;
while sentiment given news is simply
noise. Once again, it must be pointed out
that the OSI is still able to profit from the
noise, capturing profitable temporal price
swings as a trading program.
“OSI is still able
to profit from the
noise, capturing
profitable temporal
price swings as a
trading program.”
OSI Summary
The OSI is an intraday indicator
based on end-of-day data without
momentum; each day’s buy or sell
signal is valid for that day only.
From the backtest results we see
a winning percentage at or greater
than 50% with the OSI; this is in
line with previous statistical tests
from all population datasets when
testing the OSI. The options data for
constructing the daily trade signals
was compiled from Market Data
Express, summarizing the total open
interest from FXE.
When combining this indicator
with the five-day raw score and
CEFD indicator, the backtest results
improved significantly with a winning
percentage of 58%, albeit generating
much fewer trade signals.
In short, a sentiment prediction
model can profit from the noise, and
when combined with a noise trading
indicator such as the OSI, our proxy for
the SMF shows improved results.
Philipe Saroyan is a freelance
writer who works on sentiment
research, digital content creation
and web development.
Issue 536
Dry weather in the Northern Plains
created a soybean scare and perhaps an
opportunity for value traders.
Summer Weather
Rally Primes
Premium Pump
Q By James Cordier
In our analysis of corn and soybean
markets from May and June, we highlighted
a burdensome supply picture. However,
for both markets, we suggested summer
weather rallies might offer opportunities for
selling inflated call premium.
If you’ve been waiting for one of those,
you now have it. In the first half of July, soybean prices rallied roughly 13% while corn
prices jumped more than 10%.
Why? Weather.
But not where you might think. A ridge
over the Dakotas has brought a spell of
hot, dry weather to crops grown there. And
while you may not think of North and South
Dakota as soybean country, more than 14%
of the U.S. crop is grown there.
Does that mean that the U.S. corn or
soybean crop is in danger of a substantial
loss? Probably not.
The irony of this summer’s weather is that
while Dakota crops are certainly stressed,
crops in core growing regions of the Corn
Belt in Illinois, Indiana and Ohio are experiencing near ideal conditions. However,
that has not stopped the weather bulls from
blowing their annual trumpets.
The Fundamental Facts
Yes, there is a weather issue in the Northern Plains. As of mid-July, 72.8% of North
Dakota and 72.4% of South Dakota are in
a drought. Wheat, soybeans and corn have
all rallied as a result (see “Summer scare,”
Here, we focus on soybeans. Corn will
likely be the least affected of the three
because less of it is grown in the Dakotas,
and wheat is a different animal altogether because it has more of an international aspect.
The fear is this: Although only 14% of the
U.S. soybean crop is grown in the Dakotas, even a slight drop in yield could have
a noticeable impact on ending stocks. For
instance, the U.S. Department of Agriculture’s projected average yield for the 2017
soybean crop is 48 bushels per acre. If
that drops only by two bushels per acre,
soybean ending stocks could drop by nearly
40% of current projected levels. Worthy of
consideration? Of course. But it will take
one heck of a crop setback in the Dakotas
to have a two-bushel per acre impact on
the entire crop – especially with a virtual
greenhouse effect occurring in the central
and eastern growing regions.
The market could be starting to realize
that soybean prices were sharply off their
highs in the second half of July. This is
largely the result of a moderating near-term
weather outlook and a ho-hum USDA supply demand report on July 12.
“It will take one heck of a crop setback
in the Dakotas to have a two-bushel per
acre impact on the entire crop.”
October 2017
The USDA projected U.S. soybean
ending stocks for the 2017/18 crop at 460
million bushels – slightly lower than the
average estimate of 485 million bushels, but
still at their highest levels since 2006/07
(see “Big crop,” right). This is largely the
result of crisp demand.
More importantly, the USDA raised global
ending stocks to 93.53 million tons, up from
92.22 million tons last month. This is largely
the result of higher production out of South
America. The key is this: While it’s true that
the USDA estimate does not yet reflect any
yield loss to the 2017/18 crop, the market is
likely already in the process of pricing it in.
Worlds don’t end because the crop gets
a bit of yield shaved off. What happens is
that prices will adjust higher to reflect the
slightly lower supply. The problem with
weather markets is that nobody knows how
much lower that supply will be, and thus,
they just buy, buy, buy – often blindly.
The result is that weather markets will
often price in a worst-case scenario – producing a surge in both prices and volatility
– only to come tumbling down later when the
damage turns out less than the worst-case
scenario. Thus, trying to time or short-term
trade weather markets is futile and not recommended.
But for option sellers, these can be the
best of times. Surges in volatility can make
the ridiculous strikes discussed in past
articles, available to traders.
It is common for retail traders to get
whipped into a frenzy and bet on a worstcase scenario. The option seller can take
a position to profit from anything less –
and in some cases – even if a worst-case
scenario occurs.
Too Late to Sell Bean Calls?
Traders used to trading the underlying
futures contract may feel they need to time
the market right, to pick the top so to speak,
to make money on a price retreat. This is not
necessarily so when selling options. Thus,
even when a market has crested and prices
are in decline, a call seller can still make
money. This is especially true in the case of
weather markets.
Why? Because the volatility created by the
M o d e r nTr a d e r. c o m
As of mid-July, 72.8% of North Dakota and 72.4 percent of South Dakota are
in a drought.
Source: eSignal
The July 12 USDA crop report projects U.S. soybean ending
stocks at their highest levels in more than a decade.
Source: eSignal
weather rally can remain in the option long after the rally is over. In soybeans, this is often
true even after the critical podding season
has ended and the crop has, in essence,
been made. Thus, although the primary risk
of crop damaging weather is over, the option
market is not yet reflecting this. These can be
excellent times for selling options.
While the short-term weather forecast
is moderating, longer-term Dakota weather
models remain unclear. We are not here to
predict the weather; nor should you. What
M o d e r nTr a d e r. c o m
is clear is that to get a two-acre per bushel
reduction in total U.S. yield, it will take a
nearly 50% loss of the Dakota soybean
crop. This would put 2017/18 U.S. ending stocks somewhere between 240-290
million bushels. This appears to be the
worst-case scenario the market was pricing
in in July. While that would almost certainly
require a price adjustment higher, it would
still be the second largest ending stocks in
10 years.
As discussed earlier, worst case sce-
narios are by definition unlikely. If weather
moderates ahead of soybean podding in
August, soybean prices will likely adjust
lower. Another spate of hot weather could
give prices another jolt.
We would view such rallies as opportunities to sell over inflated call premium to
weather speculators unfamiliar with the core
fundamentals. The early July weather rally
was such an opportunity in both soybeans
and corn. Keep alert for another one in the
coming weeks.
Traders should consider the March
Soybean 13.00 call on rallies and even the
14.00 call should prices break above July
highs. Weather rallies are tough on shortterm traders. But they can bring the gravy
for fundamentally informed option sellers.
Use the public excitement to the benefit of
your bottom line.
Commodity Markets
This concept is true for most commodity
markets that have measurable seasonal tendencies. While we have been talking about
grains in general and soybeans in particular,
other commodity markets provide opportunities from periods of seasonal related
volatility. Coffee, for example, often provides
opportunities from spikes in volatility due
to the threat of frost, which occurs in our
summer months as coffee is mainly grown
in the Southern Hemisphere. In most years
the residual inflated premiums persist past
the point where there is a legitimate risk of a
frost induced spike.
In trading options, and trading in general,
the key is to find an edge. In a sense all trading is value trading and successful option
writers attempt to find value in premium. A
common cliché of option writing is that the
option writer is picking up nickels in front of
a steamroller. While we could dispute this
characterization, the point for the trader is to
find trades where that steamroller is further
down the road and that premium levels have
risen to the point that they are able to pick
up quarters.
James Cordier is author of The Complete Guide to Option Selling, and president and head trader of OptionSellers.
com, a wealth management firm specializing in option writing portfolios.
Issue 536
Everyone likes a bonus, and
options offer a unique way to book
extra profits with little risk.
Q By Robb Ross
Sometimes life hands us unexpected
opportunities, like getting selected to shoot
a basketball from half court for a $10,000
prize. You only need two qualifications: get
selected and make the basket. Everyone
likes to get a bonus; traders are no
The bonus trade was discovered after
decades of option trading and testing.
It is a secondary chance to increase a
profitable trade or turn a losing trade into
a winner. On occasion, this profit can be
substantial. This trade works with options
on futures, stocks or exchange-traded
funds (ETF).
The first part of the trade involves owning
a long option contract. This strategy works
with either puts or calls. There are many
reasons to have a long option position.
The trader could have bought the option in
hopes of a directional move, but there are
other scenarios as to why a trader would
be long an option. They may have bought
puts as insurance for a long-only portfolio.
This is common for equity funds. They are
long stocks and will buy puts as insurance
against a down move.
There are also spread scenarios:
Calendar spreads, credit spreads, debit
spreads, ratio spreads, butterflies, iron
condors, etc. Each of these option
strategies is used for a specific purpose
and involves at least one element that is
long an option. When these positions are
being rolled off, a bonus trade opportunity
presents itself.
“The risk on the trade is
actually the miniscule time
value on the call.”
October 2017
To understand the value and
movement of option prices, you need
to understand the Greeks.
ɆRho:Interest rate. Why sell an option
and take a risk if the return on the
option is equal to or less than a riskfree interest rate? This is why risk-free
interest rates are used in the option
model calculation.
ȺdŚĞƚĂ͗Time value. How much time
(life) is left in the option? Obviously,
options that expire much further down
the calendar road will have more time
value (Theta).
ɁsĞŐĂ͗Volatility. The more volatile
the underlying entity is the more that
effects the price of the option.
ȴĞůƚĂ͗Measures how much the option
should move based upon a move in the
underlying entity. A Delta of 20 means
that for every $1 the underlying moves
the option should move 20¢.
ȳ'ĂŵŵĂ͗Tells us how much the
Delta should move based upon a
move in the underlying. If the Gamma
is 10 and the Delta is 20, a $! move in
the underlying would now cause the
Delta to move from 20 to 30; hence a
move of 10.
The bonus trade is a two-step process:
own an option, and then simply engage the
underlying futures or equity. Most times,
because the option is way in-the-money,
the trade will put you in a near Deltaneutral position.
Options have several components
that are referred to as the “Greeks.” The
mathematical model for options is based
on calculations of the Greeks and traders
need to understand how they work (see
“Why options move,” above).
Here, we use examples from options on
futures, but the bonus trade will also work
with options on equities and ETFs. The
bonus trade involves owning an in-themoney option.
M o d e r nTr a d e r. c o m
The bonus trade allowed us to nearly double our profit in one day.
Source: eSignal
A Crude Bonus
A trader placed a crude oil futures call
debit spread in October 2015. The trader
bought the 47.00 November call and sold
the 48.00 November call. The 47 calls
were bought for 66¢ and the 48 calls were
sold for 44¢, creating a net debit of 22¢
(-$220/contract). This was the max risk.
By Oct. 9, 015 crude oil futures had
moved to $49.67 per barrel. The 47 calls
were now worth $2.85 and the 48 calls
$2.04. If exited on Oct. 9, the result
would have been a $590 profit (81-22=
59 or $590) on the trade, not including
commissions. But instead of rolling out
of the long call, it was time to engage a
bonus trade. The call had 18¢ of time
value. This can be calculated by adding the
$2.85 premium in the call to $47, which
equals $49.85 and subtract the futures
price ($49.85-$49.67 = 18¢). This would
be the entire risk on the bonus trade. To
engage the bonus trade the trader exited
out of the short 48 calls, leaving a long
47 call position. Next the trader shorted
the underlying futures at $49.67 (see
“Squeezing extra profit,” above).
The safety aspect of this trade is that if
M o d e r nTr a d e r. c o m
November crude oil kept rising, the risk on
the trade is actually the miniscule time value
on the call. If the market rallied the in-themoney call value will move 1 to 1 with the
short futures. In this case there was 18¢
of time value. If the price rose to $100 the
cost would still be 18¢ (see below).
Futures: 49.67 – 100.00 = -50.33
Option: 100.00 – 47.00 (strike price) =
53.00 – 2.85 (cost of the option) = 50.15
50.15 – 50.33 = -0.18
From a Delta perspective, the bonus
trade starts off as a near Delta neutral
trade. Remember, Delta is a measurement
of how much the option will change in
price for a change in the underlying. A
long futures position has a Delta of +1.0
because for every 1.0 point move in the
underlying futures contract, the options
contract moves 1.0 point. A short futures
position has a Delta of -1.0. For every point
in a down move the option will move -1.0.
This seems redundant, but is important
when trying to understand options.
In the case of this trade, the short futures
has a Delta of -1.0. The 47.00 call has a
Delta of 0.99. Therefore the position is at
a Delta of -1.0. A Delta of +/- 0.5 is what
the bonus trade is looking for. The trade
is almost Delta neutral with a lot of upside
potential. The 18¢ is the time value when
we got into the trade. So, even if crude oil
rose above $50 in a short period, the risk is
still just the time value.
Now the reward portion is twofold. Let’s
say the market drops to $47, which is our
call strike. The call would then have a Delta
of 0.50; the futures are still at a Delta of
-1.0. The position would then have a Delta
of -0.50. Since we are short the futures,
this turns into a profitable trade. The next
trading day, Monday Oct. 12, the November
crude futures closed at $47.09. The 47.00
call is now worth 84¢. The volatility is at
48% and the Delta is 0.5273. This has
turned a -1.0 Delta to a -0.4727 Delta.
Because the trader is short the futures
at $49.67, this is a really good one-day
event. The profit on the futures is $2,580
($49.67 – $47.09 = $2.58, $2,580 on
a 1,000-barrel contract). The option has
dropped in value from $2.85 to 84¢. We
exited the 48 short call at $2.04 for a
net loss of $1.60, and the 47 long call at
84¢for a net profit of 18¢
Bonus trade
48 call: Sold @ $2.04; Bought @ 44¢;
P/L = -$1.60
47 call: Sold @84¢; bought @66¢; P/L =
Futures: Short @$49.67; Exit @ $47.09;
P/L = +2.58
2.58 + 18 - 1.60 = 1.16 * $1,000/barrel
Issue 536
By entering a bonus trade, we were able to add additional profit.
Source: eSignal
= $1,160 - $590 (profit without bonus
trade) = additional $570 in profit
The bonus trade, one day later, with very
little risk, added another $570 in profit
nearly doubling the total amount made. If
the price of crude dropped to say $40,
the profit could have been even more
pronounced. However, it’s best to exit the
trade when the option Delta hits 50%. At
this point, the option is all time value.
For long puts the trade works just
the opposite. The trader goes long the
underlying futures. This trade starts near
a Delta neutral position. If the price keeps
dropping then the put is a hedge against
the futures so there is downside protection.
However, if the price rises the Delta
difference will become more positive. If the
price reaches the put’s strike then there will
be a Delta difference around 0.5 with the
long futures at +1.0 and the long put at -0.5.
Euro bonus
On July 18, 2017, with the September
euro currency futures trading at 1.1599,
a trader bought a weekly euro 1.1700 put
at 131 (131 points in-the-money) with an
expiry on July 28. The next day, July 19,
the September euro dropped 44 ticks and
closed at 1.1555. The option is now worth
162. The gain on the initial trade is 31
full ticks or $387.50 (0.0031 * 125,000
contract size). There are 17 ticks of time
value left on the option.
Instead of exiting the trade, the investor
decided to place a bonus trade. Since the
trader already possessed the long put,
they then went long the September euro
futures at 1.1555. On July 20, the euro
rallies 100+ points and closes at 1.1660.
The 1.1700 weekly put is now worth 75.
The trade is held to July 21. The euro
continues to rally and closes at 1.17135.
The futures has gained 158.5 ticks
($1,981.25). The weekly euro 1.1700 put
is now worth 39. The option is completely
at its all-time value. The trade is exited.
The trader lost 123 ticks on the option, but
gained 158.5 ticks on the future. That is
a net gain of 35.5 ticks or $443.75. The
trade risked the initial time value of 17 ticks
($212.50). Therefore the bonus traded
added another $231.25 (see “Turning a
trade,” above).
When the trader owns a deep in-the-
“The bonus trade works best
when you can pick up a long
option at a discount.”
October 2017
money option, many times there is not
enough liquidity to allow the trader to exit
at a fair price. Therefore, a bonus trade will
lock in a set amount of risk and also give
the chance to receive a bonus if the market
moves against the option before expiration.
The cost is the time value of the option.
The trader doesn’t have to be in an
existing long option trade to engage in
a bonus trade. You could just buy an
option and engage in a bonus trade near
expiration. But then again they could just
buy an opposite out-of-the-money option.
So, instead of owning an in-the-money
call option and shorting the futures, you’d
just buy a put at the same strike price as
the call. Same goes for the long put side.
Instead of having an in-the-money put and
going long the futures, the trader could
buy the out-of-the-money call at the same
strike as the put strike price. This would
be a synthetic bonus trade. As long as
the time value is equal or better than the
bonus trade then it would be a synthetic.
The bonus trade works best when you
can pick up a long option at a discount.
This would actually guarantee a profit even
if the market moved sideways or against
the futures position.
Robb Ross is the founder of White
Indian Trading Co., and the author
of the upcoming book, 21st Century
Technical Indicators.
M o d e r nTr a d e r. c o m
The plethora of derivative products
in the grain complex provides
opportunities for profitable trades
in weather-driven markets.
Grain Markets
Q By: Paul D. Cretien
From the middle of June through July this summer, the weather
in the western United States has been too hot for corn, wheat and
soybean crops. “Summer heat makes grains explode” (right) shows
the effect of hot weather that followed a more moderate period
from March through early June in which the three September
futures contracts experienced declining prices.
Although wheat futures were in the middle of the price declines
from March through early June, the hot weather in June and
July had its greatest effect on wheat. September wheat futures
escalated from a -2% cumulative price change to up 15% from
June 23 to June 28. “Summer heat makes grains explode” also
shows that September corn and soybean futures rose along with
wheat, although the hot weather had a lower effect on corn and
The difference in price changes for the three grains in early
July 2017 suggests potential trades that depend on wheat futures
falling back toward their usual relationship with corn and soybean
futures, or perhaps lower in price. Because corn and beans rest
at a zero cumulative price change on July 11, 2017 (while wheat is
at +15%) it is easy to imagine the spreads between grain futures
declining though their delivery date in September.
Grain ETFs
The hot weather in June and July had its greatest
effects on wheat.
Source: CME Group
Cumulative Percentage Price Changes.
The WEAT ETF has been more volatile than corn
based on cumulative percentage price changes.
Source: Teucrium
Cumulative Percentage Price Changes.
In addition to grain futures, there are several exchange-traded
funds (ETFs) with price movements that closely reflect those of the
underlying futures contracts. The Teucrium Corn Fund (CORN)
mirrors corn futures, the Teucrium Wheat ETF (WEAT) follows
wheat futures and the Teucrium Soybean ETF (SOYB) mirrors
soybean futures. CORN and WEAT are shown over the April to
July period in “ETFs CORN and WEAT” (right). Both of the ETFs
have price increases in July, although WEAT started rising earlier
and is more volatile than CORN.
M o d e r nTr a d e r. c o m
Issue 536
Volatility in wheat has been greater than corn during
the western heat wave in July.
Source: CME Group
Source: CME Group
Traders can monitor the upper and lower breakeven
levels through a study of call prices.
Source: CME Group
The total variation in WEAT, a cumulative
increase of 10% from March 1, is smaller
than the variation in wheat futures, 15%,
but it is still wide enough to suggest a
spread trade among the grain ETFs might
be profitable. A trader could sell WEAT and
buy CORN in anticipation of a reversion to
the mean on the basis of the two futures
Using Options
Options trades are also possible; buying
wheat puts until the price of wheat falls
to the level of corn or below in terms of
cumulative percentage price changes.
After wheat achieves a lower price, buy
September or December calls on wheat
and look forward to the next short-term
peak in price.
Trading ETFs in place of grain futures
contracts is dependent on the close fit
in price movements between ETFs and
futures. ETFs that do not have a bullish or
bearish bias usually have the objective of
reflecting the price changes in near-term
futures contracts. If the spreads between
futures prices decline, price differences
between the ETFs that follow them should
correlate closely.
Options on the grain futures are also
potential sources of trading profits as the
result of weather effects on grains. “Wheat
“The difference in price changes
for the three grains in early July 2017
suggests potential trades.”
October 2017
and corn calls” (above) shows that the
option price curve for calls on wheat is
higher than the corn option price curve.
This difference is expected due to the
options market noting the weather-related
surge in wheat futures prices compared
to the price movement in corn futures as
well as wheat’s normal higher volatility. In
the March to July period wheat was more
volatile than corn, and the higher volatility is
reflected in a higher call price curve.
An option price model for corn futures
is shown in “The skinny on corn options”
(above). The dollar variances between
market prices for the calls and prices
predicted by the log log parabolic (LLP)
options pricing model are too small to
suggest trades taking advantage of
underpriced or overpriced calls. However,
the upper and lower breakeven prices
(futures prices at expiration that would
result in zero profit from a delta-neutral
spread trade between calls and an
M o d e r nTr a d e r. c o m
“The price of grains
has a strong
impact on markets
such as livestock
and energies.”
underlying futures contract) indicate the
options market’s forecast of price ranges
near expiration in December for corn
futures. The breakeven price spread is
$4.55 to $3.51, compared to the current
December price for corn of $4.0475.
For strike prices near the current
wheat futures prices on July 11, 2017, the
breakeven prices for wheat are $6.38 to
$4.72; an average of $5.55.
The averages, or mid-range breakeven
prices, are close to the underlying futures
prices on July 11 as the options market
forecasts a spread up and down from
the current price. A trade planned to take
advantage of the current price differences
would result in a maximum profit, using
the lower breakeven price for wheat and
the upper breakeven price for corn, of the
futures price spread.
Trades in July 2017, based on futures
contracts expiring in December 2017,
include Delta-neutral spreads on corn,
wheat, soybeans and live cattle. Each
trade is made in reference to the upper and
lower breakeven prices for calls because
those are expiration price ranges that the
options market considers reasonable in
light of predicted volatility of underlying
futures prices.
An example of the delta neutral trades is
shown in “The skinny on corn options” and
“Delta neutral” (page 74).
Know your Delta
As shown earlier, corn is not as volatile
as wheat and because of the volatility
difference, it is expected that Delta-neutral
M o d e r nTr a d e r. c o m
Large fluctuations in the price of corn create losses
for a delta neutral trade.
Source: CME Group
trades in corn
should perform
better than delta
neutral trades in
Livestock (live cattle and lean hogs) prices often
wheat. “Corn delta
follow movement in grain prices because of the cost
neutral” (above)
of feed.
shows that the
maximum profit on
the trade occurs
at the strike price
chosen to trade
calls against the
underlying futures
contract. For this
reason we are
not looking for
volatility in this
delta neutral trade,
but prefer futures
prices that stay
close to the middle
of the expected
cattle and hog futures.
price range. A glance at the profit and
Grain futures, options and ETFs offer
loss column of Delta-neutral confirms that
serious losses occur when the futures price a wide range of potentially profitable
trades. Because they are subject to the
strays too far up or down. Futures price
changes that threaten the high and low loss same strong seasonal and weather-related
forces, any anomalies in the price of
ranges would require protective trades to
the various derivative products offer an
reduce risk.
opportunity for a profitable trade.
As shown in “ETFs show effect of grains
There are many ways to counteract the
on livestock” (above) the price of grains
risks and take advantage of unusually large
has a strong impact on markets such as
price spreads. A careful study of the various
livestock and energies due to corn’s use
prices and their relationship to each other
for feed and in ethanol. After falling in price
provide clues to the curious trader.
through the early part of 2017, the feed
grains for cattle and hogs stabilized and
began to increase in April, resulting in price Paul Cretien is an investment analyst
increases for the ETF COW that combines
and financial case writer.
Issue 536
Modern Trader provides cutting-edge actionable market research
while holding analysts accountable. And, when we publish specific
recommendations, we will also let you know how we did.
Snapchat falters
Post IPO blues
On June 15, SNAP settled at its initial IPO price of $17 and then
dropped another 30% throughout the summer, accelerating on
FTSE Russell’s announcement in July, and dropping further to $12
on its Q2 earnings miss (see “SNAPped,” right).
More Brexit profits
April 2017
In our April cover feature we took a critical look at the
imminent initial public offering of Snapchat (SNAP). While
much of the professional analyst world was foaming at the mouth
for the most anticipated IPO of the year, our contributor Garrett
Baldwin highlighted numerous red flags for the social media
darling. The first of which was a structure that did not grant
voting rights to the initial investors.
This questionable structure soon bit the nascent social media
player. Confirming our outlook and adding to the summer sell-off
were index creators S&P, Dow Jones and FTSE Russell’s decision
in late July to exclude Snap from its indexes because of Snap’s
share structure that denies public investors voting rights. Being
left out of the indexes is likely to limit Snap’s growth potential
going forward.
Other red flags included its lack of profitability and an apparent
lack of a pathway to profitability as well as questions over the veracity of the company’s user growth metrics. But that did not stop
prominent Wall Street firms from pounding the table as Goldman
Sachs, Citi and Jefferies were among the 12 firms assigning preIPO “buy” ratings.
Modern Trader’s pre-IPO feature advised that “investors would
be wise to sit out the Snapchat IPO and wait for the market to
price the company accordingly in six to nine months”.
Despite the warnings flags, SNAP had a successful rollout,
opening more than 40% above its $17 IPO price and rallying
above $29 on its second day of trading. However, reality soon
set in and SNAP has steadily declined since its March 2 IPO.
October 2017
March 2017
Last month we highlighted how traders may have profited from
suggested trades from a series of articles in the December 2016,
March 2017 and April 2017 issues of Modern Trader. Author Paul
Cretien highlighted the likely fallout from the Brexit vote and how it
would play out in currency markets. The broad notion was that countries that compete for exports with Britain would attempt to devalue
their currencies, which had grown expensive versus the pound due
to the effects of Brexit. Here we point out a specific trade.
At the time “Brexit and the currency wars,” Modern Trader,
March 2017, was published, the pound had dropped 15% since
June 2016, and appeared to have found a base level. Meanwhile,
the Australian dollar had increased more than 5% during that time.
The article suggested that selling the Australian dollar and buying
the British pound on March 1 would potentially be profitable.
A trader who sold the Aussie on March first could have exited
the position on May 10 with a $2,960 profit: 7645 – 7349 = 296
ticks * $10 = $2,960. A trader going long the pound on
March 1 at 1.2349 and exiting on May 10 at 1.2992 would have
earned $4,018.75.
In reviewing the currency data on July 23, it appears that
the same trade might be repeated, selling the Aussie dollar and
buying the British pound.
M o d e r nTr a d e r. c o m
Source: eSignal
March 2017
Below are the trade recommendations from our March 2017 issue, along with an
analysis and grade on how they worked out.
Security or Sector
Value (as of
Mar. 1, 2017)
Michael Thomsett
Van Eck Vector Coal (KOL)
Joseph Parnes
Ralph Lauren (RL)
Ashraf Laidi
DJ Shanghai Index
Natural Gas
Short vol.
Soybean meal
$336 per ton
Crude oil
Yum China (YUMC)
Zions Bankcorp.. (ZION)
Umpqua Hldgs. (UMPQ)
Bank of Internet (BOFI)
Baidu (BIDU)
KOL rallied close to 10% in early spring before dipping below its March 1
level by mid-May. It rebounded in summer and is up 10% from March 1.
After remaining in a range for March and April, RL dropped more than 15% in
May, but did not reach Parnes' short target. It is currently around $75.
While much of the fundamentals behind Laidi's call--Trump Administration
protectionism and tax policy--have not happened, the dollar has steadily
declined since March 1.
The CPO anticipated the April sell-off in the Shanghai Index, but not the
sharp upward correction that followed.
The CPO called the Q1 gas sell-off but expected it to last through March and
April before reversing. Gas reversed early and the subsequent rally did not
last through summer as anticipated.
The CPO expected the euro to sell-off into May before reversing and rallying
sharply through the summer. The sell-off short and the rally came a little
Coffee sold off from March and never challenged the short call positions
Cordier recommended.
Soymeal sold off sharply through the end of June before reversing in July.
Crude oil has sold off sharply in waves, followed by upward retracements,
since March 1.
YUMC has rallied more than 40% since March 1.
ZION dropped below $40 by mid April.
UMPQ dropped more than 10% in the spring before rebounding back to
March 1 levels.
BOFI set its 52-week high on March 1 before dropping close to 30% before
rebounding in July.
The pattern called for traders to go long BIDU above $189 or short below
$162. A long was initiated in May that would have been stopped out in June.
If traders gave the long a little more line they would have been rewarded as
BIDU is currently up roughly 25% from entry level.
John Rawlins
James Cordier
Andy Waldock
Joe Cornell
John Blank
Chart Patterns
Suri Duddella
Note: Forecasts are scored A (weakest) to AAAAA (strongest) based on actual outcomes.
M o d e r nTr a d e r. c o m
Issue 536
Looking for liquidity where it exists
Parvataneni: Mitigating
risk with options
Q By Yesenia Duran
LJM Partners has done with options what few funds
have been able to do—be successful for a very long time.
The managers of the 2017 Pinnacle Award winner
for best options strategy in 2016 and past Futures Top
Trader of the year have spent about 20 years managing
portfolios of options on the S&P 500 Index futures, and
its Moderately Aggressive strategy returned 19.01% in
2016, is up 10.01% year-to-date through July, and has
been positive 13 of the 15 years since inception.
It’s an impressive track record that is replicated in the
two other strategies managed under LJM.
“We are net short volatility, meaning we are primarily
options sellers, but we also hold long positions closer to
the money to help mitigate risk,” says Anish Parvataneni,
LJM’s chief portfolio manager. “What we are trying to do
is capture the difference between implied volatility and
realized volatility—and that can be risky.”
Chicago-based LJM Funds Management was founded
in 2012 as an affiliate of LJM Partners to offer a mutual
fund version of the strategies. LJM Partners has been
managing alternative investment strategies since 1998.
LJM offers its volatility strategy in three risk levels:
Aggressive Strategy, Moderately Aggressive Strategy
and Preservation & Growth (P&G). The strategies seek to
provide a return stream uncorrelated to equities or fixed
“We are trying to capture the
difference between implied
volatility and realized volatility—
that can be risky.”
Parvataneni got into options specifically because they
have an element of quantitative math to them and that
means they have less dependency on subjective factors.
Whatever it is, it’s working, as their other strategies have
been doing well: the Aggressive Strategy was up 25.40% in
2016 and 10.89% year-to-date through July, and P&G, was
up 13.66% in 2016 and 6.05% year-to-date through July.
LJM does not attempt to forecast market direction,
it initiates market neutral positions by simultaneously
selling deep-out-of-the-money calls and puts, followed
by appropriate adjustments based on movement of the
October 2017
underlying S&P 500 futures.
The greatest risk entailed with the LJM Aggressive and Moderately Aggressive Strategies
occurs during periods of excessive volatility,
specifically large gap movements. Because the
probability of a gap movement of 10% or more
in the S&P 500 Index within a 30-day period is
far greater for downward market movements, the
trading strategies employed by LJM are cautious
of downward spikes.
As many fund managers will tell you, especially options
writers, risk management is key to staying successful.
“Sudden and extreme market movements can challenge
the strategy, but we hold long positions to help mitigate
risk,” says Parvataneni, who joined LJM in November 2010
from algorithmic trader at Jump Trading LLC. LJM was already a highly successful option writing CTA, but adjusted
its approach in the Aggressive and Moderately Aggressive
strategies in 2008—incorporating many of the risk mitigating strategies of P&G into these other programs.
LJM P&G’s goal is capital preservation in down markets and stable and consistent performance in many market conditions. “Sudden and extreme market movements
are typically to the downside. While we could take a
short-term loss in this scenario, quick downward market
movements typically cause volatility to rise and allow
us to sell options contracts at higher premium levels,”
he says, adding that many of the most common option
writing strategies, like a covered call, hold a significant
amount of assets in an underlying equity investment. So,
the goal of these strategies is very different from ours,
it’s to help mitigate the downside of an equity investment.
LJM runs a pure option strategy. “We don’t hold any
underlying assets—in our case we don’t hold the S&P 500—
just options on S&P 500 futures. So our goal is to produce
an uncorrelated return stream and in fact our strategies
range in correlation to the S&P from -0.05 to 0.28,” he says.
“Part of our risk management process is to assess
‘known unknowns’—like the presidential election, Fed
announcements, Brexit, etc.—and the risk-reward payoff
in the market leading up to these events to determine
whether we want to reduce risk or slow our contract writing. This is big part of our strategy,” Parvataneni says.
Anthony J. Caine
Strategy: Options
AUM: 1.15+ billion
Location: Chicago
M o d e r nTr a d e r. c o m
U.S. economic data & select global influences
October: Volatility ahead?
Q By: Daniel P. Collins
Vital October Statistics*
M o d e r nTr a d e r. c o m
13 16 17
Average %
Best & Worst October- % Change
19 20 23
Issue 536
Chicago PMI | Redbook | Consumer Confidence
Dallas Fed | Farm Prices
GDP | Consumer Sentiment
International Trade | Consumer Comfort | EIA Natural Gas | Kansas City Fed
ECB non-monetary policy meeting
Bank Reserve Settlement | MBA Mortgage | Durable Goods Orders | FHFA House
Price | New Home Sales | EIA Petroleum Status
FOMC Meeting
Chicago Fed
*Courtesy of Stock Trader’s Almanac 2016 ©2015 John Wiley & Sons Inc.
1950 21971
Existing Home Sales
Philadelphia Fed | Consumer Comfort | Leading Indicators | EIA Natural Gas Report
Bank of Japan Monetary Policy Meeting
MBA Mortgage | Atlanta Fed | EIA Petroleum Status
Import and Export Prices | Redbook | Housing Market
Empire State Mfg Survey
Consumer Price | Consumer Sentiment
Bank of England MPC Announcement and Minutes
PPI-FD | Consumer Comfort | EIA Natural Gas
Bank of Canada Policy Interest Rate
MBA Mortgage | Bank Reserve Settlement | JOLTS | FOMC Minutes
NFIB Small Business Optimism | Redbook
OECD Composite Leading Indicators
Employment | Wholesale Trade | Wholesale Trade | Consumer Credit
Labor Market Conditions | TD Ameritrade IMX
Chain Store Sales | International Trade | Consumer Comfort | EIA Natural Gas | Treasury STRIPS
ECB non-monetary policy meeting | Reserve Bank of Australia Interest Rate Statement
Mortgage | Employment | Job Creation | PMI Services | ISM Non-Mfg | EIA Petroleum
Construction Spending | Consumer Spending | PMI Manufacturing | ISM Mfg
Modern Trader Monthly Trading Calendar - October 2017
A year ago we pointed out that despite
October’s history as a month in which
market crashes occur, the major stock
indexes have average positive returns
in October and the month falls in the
middle of the pack in terms of average
performance during specific months.
What is clear is that volatility — measured
by the range of price movements — tends
to pick up in October. Not only has
October produced market crashes, but
it has also been a month that has seen
significant market spikes. The broadest
range in price in the S&P 500 per month
has occurred in October in four of the last
nine years.
So what does that tell traders as we
enter October 2017? If they are writing
options, it would suggest going further
out on the price curve in selecting strikes
or perhaps to be careful of short volatility
The bottom line is that stocks tend to
move more significantly, in either direction,
in October. And as of the end of July 2017,
with all the major stock indexes at or near
all-time highs, the risk of a major move is
clearly to the downside.
26 27 30 31
Guest Editorial
Revenge of
the humans
Q By Doug Litowitz
How ironic. Bloomberg is reporting that most of
the new quant strategies adopted by asset managers
aren’t generating any, uh, quantifiable positive returns,
let alone alpha. Allow me to explain in a moment of
For years I’ve listened to tedious, unproven
projections and inflated rhetoric about the promise
of big data, quantamental strategies, roboadvisers,
machine learning, web scraping and artificial
I’ve been told that humans were passé. I’ve been
handed the new quant bible, Homo Deus by Yuval
Harari, which argues that human beings are merely
algorithms made out of meat, and the best we can
hope for is to merge with supercomputers.
Ah, yes, the golden future. Temperamental traders
replaced with placid robots, and portfolio managers
replaced with data managers that don’t swear, drink
or womanize. After all, only a PhD can design an
algorithm that web scrapes for how many times Target
loop” for the time being. How magnanimous. It’s like
my laptop telling me that I have to leave the house and
move into the little room above the garage.
Many of us anticipated this failure (see “The
quantitative tipping point,” right).
First, algorithms only work ceteris paribus, i.e., in a
closed system where all other things are equal. But a
closed system is never the case. Markets are affected
Computers cannot
understand symbolic human
communication because they
lack any social context.
It’s like my laptop telling me
that I have to leave the house
and move into the little room
above the garage.
is searched on Google, and then combines this with
credit card records from Visa and compares this to
Facebook “likes” and adds a prediction based on
photographs from drones circling the parking lots, puts
all this alternative data into context with the historical
movements of the stock and the indexes generally, and
arrives at a nearly infallible prediction of how the stock
will move. And it will even learn from its mistakes.
I even heard that one of the new prophets of AI
conceded that we should “include humans in the
October 2017
by wars, famines, political posturing, central bank
interventions, mass delusions, apocalyptic rhetoric,
crypto-currency survivalists and even the weather. No
computer can figure all this out.
Second, computers cannot understand symbolic
human communication because they lack any social
context. The economy is a human construction and it
is symbolic and cultural all the way down. There is no
mathematical formula lying below the surface waiting
to be discovered. No matter how fast an algorithm
is, it cannot listen to an investor presentation and
decode clues, get an intuitive feel for situations, pick
up vibes and develop a feel for what the speaker may
be feeling.
Consider the battle over Herbalife (HLF). No
matter how good a computer could crunch the
numbers, the decisive factor moving the stock
price was a monumental clash of egos between Bill
Ackman and Carl Icahn. No algorithm can compute
pride, narcissism, recklessness, self-promotion and
feigned indignation. These same factors are at play in
most if not all companies.
M o d e r nTr a d e r. c o m
It’s not cuttingedge to stick your
own hand inside a
puppet and then let
the puppet tell you
what to do.
The great philosopher Immanuel Kant said, “Out
of the crooked timber of humanity, nothing straight
was ever created.” This means that as long as human
beings are running the show, everything that they
touch — from politics to economics to relationships
— will be largely irrational, chaotic, indeterminate
and contestable. The upper hand will always go to
the human being who has studied non-mathematical
subjects like history and psychology. It’s true that
in closed systems like chess no human can beat a
computer, but the superiority of the computer is only
made possible by reducing the messiness of the real
world to the artificial construct of a game.
Need further proof? Consider waking up to find
that the entire market was down because a maniacal
dictator halfway around the world sporting a bad
haircut is shooting nuclear-capable rockets in our
direction. Please tell me what computer, what
algorithm, can reduce that to a mathematical formula?
Third, there is a problem of the commons. Once a
single firm uses an AI strategy, other firms copy it, and
this reduces the spreads and eliminates the edge. If
all the computers are learning from each other and
their own mistakes, they will eventually reach parity
and eliminate any edge for a single fund.
And yet the myth persists even among legends.
Dealbreaker reported that Paul Tudor Jones II had cut
“15% of the humans” at his hedge fund (as opposed
to cutting 15% of the furniture?), and proclaimed,
“No man is better than a machine, and no machine is
better than a man with a machine.”
Anyone who has watched Jones give a Ted talk
knows that he is concerned with corporate justice,
alleviating poverty and with improving education.
But surely he knows that we’ve had the world’s most
powerful computers for decades, and yet these
problems persist. To think that computers can solve
investment problems but not other human problems is
M o d e r nTr a d e r. c o m
The quantitative
tipping point
Investment banking firm Jefferies recently produced the white paper
“Quantifying Intuition: Mapping the Data Science Landscape in the Hedge
Fund Industry,” which argues that we have reached a tipping point where
data science is now, and will increasingly be, of strategic importance to
all hedge funds. The paper had the following five main themes.
1. Data science is an exciting, innovative and critical business
strategy issue – but it also remains a completely amorphous
This is not limited to hedge funds. CEOs across all industries are
feverishly working to understand the impact of disruptive technologies
on their businesses.
2. Hedge funds are in different stages of embedding data
science across their organizations – but funds of all shapes,
sizes and strategies are increasingly dedicating headcount and
resources to the space.
Jefferies estimates more than 20% of the current Billion Dollar Club
has someone who spends at least half their time focused on the issue.
3. “Excel is not a strategy.” PMs, analysts and traders want to
understand possible solutions, ranging from unstructured big
data feeds to machine learning tools or technology consulting.
Even firms that may not have a long history of quantitative experience
are elevating this issue to understand what potential exists.
4. Successfully implementing data science across hedge funds
can be tricky, and cultural challenges may create unintended
It’s not enough to say: “Get me a quant, any quant!” Hedge funds are
idiosyncratic organizations, and they need to think strategically about
the purpose, implementation and execution of these solutions for their
specific firm.
5. Many questions remain about data science – ranging from
legal and regulatory to existential.
Will machines eventually out-invest humans? We’re still in the nascent
stages of these innovations and their long-term implications are still
taking shape.
to divide the world artificially, and wrongly.
At bottom, computer worship is simple paganism —
a person carves a god from a piece of wood and then
claims that the god created him instead of vice versa.
We do the exact same thing when we create and then
bow down before our own metallic creations.
Corporations are not people. And neither are
computers. SIRI is not your friend, and your Japanese
sex bot is not your wife. It’s not cutting-edge to stick
your own hand inside a puppet and then let the
puppet tell you what to do.
Doug Litowitz is a hedge fund lawyer and former law professor.
Issue 536
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