Trading Home Depot around Hurricane Irene: Post-Mortem

On Friday, I outlined a few HD options strategies to profit from the weekend super-storm Hurricane Irene (The Perfect Storm: Trading Home Depot around Hurricane Irene).  Today (Monday 8/29 11:30AM EST), the storm has passed. As expected, implied volatility in HD has collapsed back to it's historical average (32.5%). Let's take a look at how the various recommended strategies fared.

"For long-term HD shareholders: Sell out-of-the-money calls, like the Sept 35 Calls for .70.  By selling out-of-the-moneys, you won't run afoul of the IRS and won't owe any taxes on the underlying shares unless they're exercised. If they're called away, you'll have benefited from this week's 7% gain,  plus .85 appreciation (2.5%), plus .70 options premium (2%). Total profit since last Friday: 11.5%. Profit from today: 4.5%. Not bad in a low-return world. You can also buy back the calls on Monday, after volatility collapses, if you're married to the stock."

Sept 35 Calls are now at .46 (IV is now 31%). Close the position for .24 profit (34% on the options or .7% on the underlying).

"For short-term HD shareholders: Sell slightly in-the-money calls, like the Sept 33 Calls for 1.85.  This gives you a .70 (2%) premium in a pretty sleepy stock, and it can drop nearly 4% before your protection runs out.  Of course, you're giving up any upside if Irene is even worse than expected, and HD adds to it's already impressive run.  Still, you will benefit from collapsing IV."

Sept 33 Calls are now at 1.45 (IV is 34.7%,  time premium is .45).  Close the position for a .40 profit (24% on the options, or 1.2% on the underlying).

"For non-directional options traders: Sell high-IV options, and protect yourself with lower IV options. For example, sell the Sept 30 Puts for .27 (IV=50%) and buy the Nov 30 Puts for .97 (IV=40%) for a net debit of .70. Cover early next week for a small profit as IV collapses. Even bigger bump if HD fades."

Sept 30 Puts now .21 (IV=47.44%), Nov 30 Puts now .90 (IV=38.72%). Spread is now .69, basically break-even with Friday's spread of .70. Not worth the trouble.

"For bullish options traders: Sell high-IV puts. For example, sell the Sept 32 Puts for .54 (IV=41%). If HD rallies next week, pocket the .54. If it drops, you can buy it 9.4% cheaper if it falls through 32 (your breakeven is 31.46, 10% below today's price). Don't be afraid of selling naked puts! It's a very conservative strategy; Warren Buffet uses it to buy companies he likes at a discount, and generate income to boot."

Sept 32 Puts now at .47 (IV=38.5%). Close the trade for .07 profit (13%). Probably not worth it, on a risk-adjusted basis.

"For bearish options traders: Sell high-IV calls, like the Sept 33 Calls for 1.80 (IV=38%). If HD drops next week, pocket the .65 risk premium, plus whatever the drop is, to a max profit of 1.80 at 33 or below. If it rallies into expiration, your effective short price is 2% higher than today's price."

Sept 33 Calls are now at 1.45 (IV is 34.7%,  time premium is .45).  Close the position for a .40 profit (24%).

"For neutral options traders: Sell at-the-money puts and calls.  Sell Sept 34 puts for 1.10, Sell Sept 34 calls for 1.13. (HD now at 34.30). Trade is a winner if HD closes between 31.77 and 36.23 on 9/16. Or, exit the trade early next week. Seems like a nice risk/reward here as premium covers +/-6.5% move in 3 weeks."

Sept 34 Calls at .86 (IV=32.67%), Sept 34 Puts at 1.15 (IV=33.2%). Close the combination for a .22 profit (10%).

Of course, you can also let the trade run, either for a few more days as damage estimates are fine-tuned, or even all the way to expiration. The advantage to the last approach is you save money on commissions and "slippage", and the result may fit your overall portfolio strategy.

Conclusion: 4 wins, 0 losses, 2 ties. Not too bad! To re-emphasize the most important point from the original post, never go long options into an approaching natural disaster! Everybody knows it's coming, but nobody knows how bad the damage will be. You will be paying a high price to gamble on Mother Nature, as premiums will be inflated. Those premiums are sure to return to their baseline when the event has passed.
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How is Greece like your brother-in-law?

You've worked hard your whole life. You've scrimped and saved and, by the grace of God, you've managed to buy a nice home, provide a comfortable life for your family, and put a little away for a rainy day. Things have worked out for you.

Your wife has a big family, and you love them dearly. Her brother Billy has 7 kids, and they're beautiful and engaging. Everybody loves them. Unfortunately, your wife's brother is a deadbeat. He likes to gamble, smoke pot, get drunk, and can't keep a job. You've tried to talk to him about these problems, but he gets very defensive, says things are about to turn around. But they never do.

Your deadbeat brother-in-law has really done it this time. He bet $5,000 on the Steelers to win the Super Bowl. Thought they were a sure thing. Turns out they weren't. Of course, Billy has no money to pay the bookie, who's very large and not very empathetic. So of course, Billy wants to borrow money from you.

You'd love to tell your brother-in-law to f**k off, let him get roughed up (or worse). He deserves it. Maybe he'd even learn a lesson. But your wife, and her whole family, are very protective of him. If you don't save him, you're the jerk. If anything were to happen to Billy, your wife and her whole family would hate you forever. But, if you bail him out, he'll never change. Even now, he's unapologetic. It's the bookie's fault for being so tough on him, his ex-boss's fault for firing him, even Ben Roethlisberger's fault for not playing better in the Super Bowl. You now hate his friggin guts.

As you've guessed by now, your wife and her family are the Eurozone, your brother-in-law is Greece, and the bookie is the Greek bondholders. And you're the German government.  To make it even worse, if you bail out the deadbeat, the rest of the family will stop paying their bills, and will expect you to bail them out too. And one more thing--even if you decide to bail out your brother-in-law...I mean, Greece...you still have to convince the hardworking, thrifty German people to go along with the plan. And you'll probably be tossed from office for your trouble.


What do you do?

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The Perfect Storm: Trading Home Depot around Hurricane Irene

Today, we have a very nice setup for trading Home Depot (HD).  Hurricane Irene is currently bearing down on the Outer Banks of North Carolina,  a lovely stretch of beach in the midst of vacation season.

A brief history/geography lesson on the Outer Banks.  A famous vacation spot, The Outer Banks is a thin (usually less than 1/2 mile wide) barrier island separating the Atlantic Ocean from Pamlico Sound and mainland North Carolina.  It has been the scene of many vicious storms in the past; an 1846 hurricane opened , which is now the site of a 2-1/2 mile long bridge:

"Whoa!" you may say.  A storm did that! Unbelievable! I would never build a nice house there.  And for many years, people didn't.  Here's a typical 1960's-era cottage:

Nice! Small but comfortable, close to nature, and no big deal if it gets washed away. But, as usual, people forgot how powerful Mother Nature can be, and she fortuitously chose to ignore the Outer Banks. By the 2000's, people were building homes like this:

Ridiculous! Talk about hubris! Or maybe stupidity. Needless to say, if Hurricane Irene is anything like the 1846 storm, this million-dollar home will be reduced to splinters.

Anyway, Irene is currently headed directly for the Outer Banks. After that, it's projected to roll through the heavily-populated Northeast USA, from Washington to Boston. Damage is projected to reach the billions. And when residents wake up Monday morning, and start repairing windows, doors, shingles, and possibly rebuilding homes, where will they start?  Yup, Home Depot.

Of course, if I know this so does every wit and half-wit with a brokerage account. Consequently, as the storm track has crystallized, HD stock has been ramping up. It is currently trading at 34.15, up 7% from last Friday's close at 31.88. Here's the kicker: since Irene's full thrust will be felt mostly tonight and this weekend, the ultimate damage will be done while the market is closed. This means that a nimble options trader can profit a bit more from a post-storm "sell the news" move in HD.

HD's historical volatility is about 32%. September around-the-money options are trading at implied volatilities from the high-30s to nearly 50 (Sept 30 Puts). The smart(?) guys are betting on the weather! I expect implied volatility to collapse back to it's long term average on Monday. So the play today is to sell volatility. Here are a few possible strategies.

For long-term HD shareholders: Sell out-of-the-money calls, like the Sept 35 Calls for .70.  By selling out-of-the-moneys, you won't run afoul of the IRS and won't owe any taxes on the underlying shares unless they're exercised. If they're called away, you'll have benefited from this week's 7% gain,  plus .85 appreciation (2.5%), plus .70 options premium (2%). Total profit since last Friday: 11.5%. Profit from today: 4.5%. Not bad in a low-return world. You can also buy back the calls on Monday, after volatility collapses, if you're married to the stock.

For short-term HD shareholders: Sell slightly in-the-money calls, like the Sept 33 Calls for 1.85.  This gives you a .70 (2%) premium in a pretty sleepy stock, and it can drop nearly 4% before your protection runs out.  Of course, you're giving up any upside if Irene is even worse than expected, and HD adds to it's already impressive run.  Still, you will benefit from collapsing IV.

For non-directional options traders: Sell high-IV options, and protect yourself with lower IV options. For example, sell the Sept 30 Puts for .27 (IV=50%) and buy the Nov 30 Puts for .97 (IV=40%) for a net debit of .70. Cover early next week for a small profit as IV collapses. Even bigger bump if HD fades.

For bullish options traders: Sell high-IV puts. For example, sell the Sept 32 Puts for .54 (IV=41%). If HD rallies next week, pocket the .54. If it drops, you can buy it 9.4% cheaper if it falls through 32 (your breakeven is 31.46, 10% below today's price). Don't be afraid of selling naked puts! It's a very conservative strategy; Warren Buffet uses it to buy companies he likes at a discount, and generate income to boot.

For bearish options traders: Sell high-IV calls, like the Sept 33 Calls for 1.80 (IV=38%). If HD drops next week, pocket the .65 risk premium, plus whatever the drop is, to a max profit of 1.80 at 33 or below. If it rallies into expiration, your effective short price is 2% higher than today's price.

(Updated 1:30pm; just thought of another one)
For neutral options traders: Sell at-the-money puts and calls.  Sell Sept 34 puts for 1.10, Sell Sept 34 calls for 1.13. (HD now at 34.30). Trade is a winner if HD closes between 31.77 and 36.23 on 9/16. Or, exit the trade early next week. Seems like a nice risk/reward here as premium covers +/-6.5% move in 3 weeks.

Note that the "wise guys" are betting on a post-Irene drop, as IVs are higher on the put side than on the call side. They're expecting a "sell the news" reaction early next week, regardless of Irene's ultimate damage. Whatever you do, don't buy options outright in this environment! You could easily be right on HD's direction, and still lose money to collapsing volatility!

Also, stick to the more liquid strikes/expirations, as volume is likely to dry up post-Irene and you may be stuck having to leg out of a multi-leg option into an illiquid market...another good way to turn a winner into a loser!

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Bernanke Knows His Keynes

"Perhaps a complex offer by the central bank to buy and sell at stated prices gilt-edged bonds of all maturities, in place of the single bank rate for short-term bills, is the most important practical improvement which can be made in the technique of monetary management."

Keynes, John Maynard (2010-12-30). The General Theory of Employment, Interest and Money Tweet

Germany Now Running the Euroshow

Fascinating read from Peter Zeihan and Marko Papic, courtesy of John Mauldin.  If you don't get John's free e-mail letters, sign up now at http://www.frontlinethoughts.com/subscribe.  He's always thought-provoking and non-partisan, with a long view. Anyway, back to Zeihan and Papic's article, "Germany's Choice: Part 2".

An introduction:

"However, with the end of the Cold War and German reunification, the Germans began to stand up for themselves once again. Europe’s contemporary financial crisis can be as complicated as one wants to make it, but strip away all the talk of bonds, defaults and credit-default swaps and the core of the matter consists of these three points:

• Europe cannot function as a unified entity unless someone is in control.
• At present, Germany is the only country with a large enough economy and population to achieve that control.
• Being in control comes with a cost: It requires deep and ongoing financial support for the European Union’s weaker members."

On Germany's policy dilemma:

"It is easy to see why the Germans did not simply immediately write a check. Doing that for the Greeks (and others) would have merely sent more money into the same system that generated the crisis in the first place. That said, the Germans couldn’t simply let the Greeks sink. Despite its flaws, the system that currently manages Europe has granted Germany economic wealth of global reach without costing a single German life. Given the horrors of World War II, this was not something to be breezily discarded. No country in Europe has benefited more from the eurozone than Germany. For the German elite, the eurozone was an easy means of making Germany matter on a global stage without the sort of military revitalization that would have spawned panic across Europe and the former Soviet Union. And it also made the Germans rich. 

But this was not obvious to the average German voter. From this voter’s point of view, Germany had already picked up the tab for Europe three times: first in paying for European institutions throughout the history of the union, second in paying for all of the costs of German reunification and third in accepting a mismatched deutschemark-euro conversion rate when the euro was launched while most other EU states hardwired in a currency advantage. To compensate for those sacrifices, the Germans have been forced to partially dismantle their much-loved welfare state while the Greeks (and others) have taken advantage of German credit to expand theirs."

On the new EFSF  (European Financial Security Facility):

"In practical terms, these changes cause two major things to happen. First, they essentially remove any potential cap on the amount of money that the EFSF can raise, eliminating concerns that the fund is insufficiently stocked. Technically, the fund is still operating with a 440 billion-euro ceiling, but now that the Germans have fully committed themselves, that number is a mere technicality (it was German reticence before that kept the EFSF’s funding limit so “low”).

Second, all of the distressed states’ outstanding bonds will be refinanced at lower rates over longer maturities, so there will no longer be very many “Greek” or “Portuguese” bonds. Under the EFSF all of this debt will in essence be a sort of “eurobond,” a new class of bond in Europe upon which the weak states utterly depend and which the Germans utterly control. For states that experience problems, almost all of their financial existence will now be wrapped up in the EFSF structure. Accepting EFSF assistance means accepting a surrender of financial autonomy to the German commanders of the EFSF. For now, that means accepting German-designed austerity programs, but there is nothing that forces the Germans to limit their conditions to the purely financial/fiscal."

Long term, this is very good news for the euro and Eurozone countries, though it may slow down Germany's growth somewhat.  There's more in the article, including an analysis of Germany's newfound heft on her neighbors. Download the whole thing here.

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Gold is the New Cash

August 3, 2011: The Day the Fiat Currency Died.  It's not as poetic as , and Don McClean won't be writing any hit songs about it, but it is a milestone in financial history.  For on 8/3,  Switzerland became the last of the strong money countries to throw in the towel, as they lowered rates “as close to zero as possible” in order to weaken the Franc and improve Switzerland's competitive position.  The prim-and-proper, all business, tight-money Swiss have given up the ghost.  There are now no safe haven currencies left.



It all started with the Asian economies, principally China and India.  China has become an export powerhouse by pegging the yuan to the dollar at an ridiculously low exchange rate.  Of course, China's gain is the rest of the world's loss, as manufacturing jobs have been lost all over the world to China and other East Asian countries that have emulated China's policies.  India has been just as effective at importing jobs by adopting the same strategy, only India's strength is in the service sector:  customer support, engineering, legal services, etc.

What is the magnitude of this currency manipulation?  Economists estimate that the yuan is about 50% undervalued compared to the dollar. The Economist magazine has just updated it's Big Mac Index, and a Big Mac costs just $2.27 in China.and $1.89 in India*!  This sandwich will set you back $4.07 in the U.S. (too damn much, IMHO) and $8.06 in Switzerland!  No wonder the Swiss decided to weaken their currency; the Swiss love them some Big Macs!  (Big Mac arbitrage, anybody?  All you need is a few hundred yuan, a big suitcase, and a one-way ticket from Beijing to Geneva.)

While the world economy grew, the USA looked the other way.  Sure, we lost jobs to Asia, but the economy was growing, Wall Street was getting rich, home values were soaring, and corporate profits were surging.  And (maybe most importantly), presidents, senators, and representatives were being re-elected.

That all changed in 2008.  The world plunged into The Great Recession, featuring the worst job losses since the 1930's.  Rich-world GDP plunged, while China and India continued to grow.  Helicopter Ben Bernanke, Tim Geithner, and President Obama pulled out all the stops: they turned the Mint's printing presses up to 11, orchestrated QE and QE2 to drive both short- and long-term interest rates into the dirt, and flooded the world with dollars.  The hope was that this would prop up housing prices, get businesses to invest and hire again, and restart the economy.  (It hasn't really worked, as housing prices bounce along the bottom and much of the new investment has taken place in China.  But that's a story for another day.)

Europe was faced with many of the same challenges, but with a twist.  Creation of a common currency had encouraged reckless borrowing by the less-productive members of the Eurozone (the so-called PIIGS).  As I write this, Europe is enmeshed in a full-fledged currency crisis.  Greece is broke and has no chance to repay large loans from big European banks.  Portugal, Italy, Ireland, and Spain are vying for second place in the race to the bottom.  Consequently, the Euro is in mortal danger, and has dropped like a stone since 2008 against the Yen, Franc, and gold.  Nobody believes in the Euro anymore, and the smart money has left town.

Now that the Swiss have given up, where can cash be safely stashed?  The dollar?  Fuggetaboutit.  The Euro?  See above.  The Yen?  Only because Japan has been in the ditch for 20 years, and have gotten comfortable there. You'll get no yield there.  The Canadian and Australian Dollars, or the Brazilian Real?  Maybe, but they're totally levered to commodity prices.  The "full faith and credit" of the USA isn't what it used to be, but we haven't sunk below Brazil yet, have we?  In the early '80's, Brazil converted the Crusado to the Cruizero by stamping "000" on their paper money...I kid you not!  When the Fed stamps "000" on Dollars and starts calling them Dollaroos, I'll move my meager savings to Brazil.

So what does that leave?  Nothing!  There are no reliable currencies left, where you can relax in cash and get paid a small amount of interest to wait. 

Wait a minute, I forgot about one currency...gold!  The has represented money since before it was called money.  It's heavy, clunky, and you can't buy a Big Mac with it, but it has held it's value better than any currency the last ten years.  Of course, it yields nothing and is difficult to store.  But today, one can buy electronic versions of gold (as easy to store as cash) and the non-existent yield matches the Dollar, Swiss Franc, and Yen.


Here's a couple of interesting graphs.  First, a few commodities priced in Dollars:

Corn and copper have more than doubled since 6/2010 and oil has been flat, indicating a healthy world economy.  Not so fast...here are the same commodities priced in gold:

Corn and copper are still up, but oil is down a third since March, and both copper and oil have fallen off a cliff the last two weeks.  The market smells a recession coming!  US Treasuries have rallied strongly and the stock market is down 8 days in a row, further signs of a coming recession.

Gold is the new cash!  Keep your idle savings in gold, rather than one of the fiat currencies.  It will preserve your purchasing power without geopolitical risk, earthquake risk, tsunami risk, Obama risk, Bernanke risk, Merkel risk, or Greek risk. 


*Actually, it's called the "Maharaja Mac" in India, presumably containing no beef.  Sounds gross. Tweet

Take Some Francs off the Table

On June 14, I shorted the Euro against the Swiss Franc (EURCHF) at 1.21.  The Euro has obediently fallen to a low below 1.08, before staging a massive rally overnight when the Swiss dropped interest rates to nada%, matching the rest of the world. (Expect this headline soon: "Swiss Bankers Head to Rio, Excited to Dance in Carnival Parade")  EURCHF is currently trading just under 1.11, time to unwind the position.

The Swiss Franc is still an unrivaled safe haven, but has gotten way ahead of itself.  We recently met some American expatriates living in Switzerland, they were stocking up on Ugh boots as they could buy three pairs in the US for the price of one in Switzerland!  Another data point: a small Diet Coke costs $12 in Zurich! We'll continue to watch the Franc for a good re-entry point.

Some of the European safe haven money will look elsewhere on the Swiss Central Bank news.  Look for the other safe havens to rally today:  US Treasuries, gold, silver. Tweet