Good Luck Getting a Mortgage Here…

I don't talk much about my trading and investing background, but suffice it to say that I have been an active investor for 25 years, have traded all sorts of options for 10 years, have accounts with about a dozen financial institutions, some of which carry what I consider to be significant balances, etc. On top of that, the options commissions alone that I generate are quite substantial.

So...just for the heck of it, I decided to open an account with Bank of America and see how well their 30 free trades a month promotion works and whether it makes sense to move a large chunk of money there and make them a part of the network of institutions with which I place most of my trades.

On their options application BofA asks the usual questions about the number of years trading options, number of trades per year, average trade size, types of trades, etc. Given the substantial history and volume I have in this area, including writing naked options on equities and indices, I was surprised that it had taken several weeks for them to add options authority to an account that I opened and funded at the beginning of the month. Finally, I get a call from them today. I returned the call and their rep proudly informed me that I have been approved for Level 3 options trading – which is their equivalent of an investor with training wheels: no authority to write uncovered puts and calls for equities, not to mention index options. I just laughed. I love thinkorswim and optionsXpress. I also think TradeKing does an excellent job with options, especially considering their pricing. No doubt those three brokers will continue to get 95+% of my options business. Fortunately, I won't have to worry about how good the options executions are at Bank of America. What a joke...

[For those who are wondering, I did not reference the blog, nor ask the person on the other end how he would go about evaluating a fair price for a VIX calendar spread when the VIX is in contango.]

Disclaimer: I have no position in BAC at the moment, but keep in mind that this is the same company that invested $2 billion in Countrywide Financial when the common stock of CFC was trading at about 26 (it is now at 9)

Other Voices on Volatility, Risk, etc.

One of the advantages of living in California is that by the time I wipe the sleep out of my eyes and stare at the computer screen for the first time each morning, bloggers from time zones to the east of me have already digested information I haven’t even seen yet and drawn their own conclusions. In many instances, this allows me to cherry pick what I think is important to ponder without having to boil the ocean along with a couple of eggs before the market opens. This particular morning, five related items are among those that are most prominent in my deliberations:

• Headline Charts has another superb overview of the current market breadth situation and concludes that it looks generally positive for the bulls.
  
  
• The CXO Advisory Group analyzes market movements around options expiration and notes a pattern of slightly elevated returns pre-expiration and slightly lower returns post-expiration.
  
  
• Adam at the Daily Options Report expands on the weather analogy as it applies to VIX options. [VIX options and the weather was one of the first subjects I tackled on VIX and More when I started blogging at the beginning of the year.]
  
  
• Babak at Trader’s Narrative discusses the BCA US Financial Stress Index and notes that while stress in the financial markets has not been this significant since the Savings and Loan Crisis of the 1980s, BCA Research remains bullish.
  
  
• Finally, the MarketPsych.com Fear Index overlays the percentage of “fear” words [the blue line] in the U.S. financial news over a candlestick chart of the NASDAQ 100.

Portfolio Rebalancing, Diversification, and ETFs

In addition to dreaming about the great investment opportunities of 2008, the end of the year is a time when many investors think about rebalancing their portfolios, enhancing diversification, and lowering risk. It is also a good time to cut loose bad ideas and bad investments, while at the same time opening one’s mind to the possibility of new types of investments.

I can’t say where the best opportunities for 2008 lie, but I can tell you where to find them. Without a doubt, many the best investments for 2008 will found among the ETF universe. This should not come as a surprise, as the ETF universe has, by far, the broadest array of investment vehicles. So while some individual stocks may top next year’s list in terms of total return, the careful selection of a few ETFs in new asset classes will provide a better opportunity to enhance returns and lower overall portfolio risk at the same time.

While there are a number of places to research and screen ETFs, I am also a fan of those handy one page ETF ‘cheat sheets’ put out by Bespoke Investment Group: the US ETF Family Tree; and the Global ETF Family Tree, each of which are superbly organized. For my purposes, however, I can do one better with a four page PDF from ETF Guide: ETF Reference Guide 2007 Q4. Updated quarterly, this document gives me four important pieces of information that are not available from the Bespoke cheat sheets:

1. Indication of which ETFs are optionable
2. Average daily volume
3. Expense ratio
4. Expense ratio median for each category

Armed with this information, now is as good a time as any to start thinking about how to take advantage of the changing mix of investment opportunities – and the ETFs that can expand the scope of your investment reach.

Was 2007 the Beginning of a New Era in Volatility?

From the chart below, it certainly looks as if 2007 was the beginning of a new volatility macro cycle. It also looks as if the rate of change in volatility over the course of 2007 is unsustainable going forward – or at least inconsistent with the slope of volatility macro cycles during previous cycles. I am not going to make a specific long-term volatility forecast for 2008, but it would not surprise me if volatility flattened out in the low to mid-20s range in much the same manner that it did from late 1998 to early 2002.

While VIX macro cycles are somewhat dependent upon a subjective determination about the beginning and ending dates for each cycle, it should be noted that these cycles tend to last a minimum of two years, suggesting that the current rise in volatility should persist through all of 2008, even if the rate of rise in volatility begins to slow.

The evolution of the current macro cycle will undoubtedly be a big story to watch in 2008; VIX and More has a front row seat to watch the action and provide the play-by-play and color commentary as appropriate.

Portfolio A1 Reshuffles Holdings for Holidays

Portfolio A1 continued its strong performance last week, with cumulative gains of 18.9% since the portfolio’s February 16^th inception – 16.9% better than the 2.0% return of the benchmark S&P 500 index during this period.

Notwithstanding the excellent recent run, this high turnover portfolio continues to seek out better opportunities and therefore dropped DryShips (DRYS) and Fresh Del Monte Produce (FDP), replacing them with Norwegian energy and aluminum giant Norsk Hydro (NHYDY), as well as The Pepsi Bottling Group (PBG), a Pepsi subsidiary. I find the Pepsi move a little surprising, especially since the portfolio had already experimented with PepsiAmericas (PAS) in November. How can a computer program have an affinity for a particular brand…?

There are no additional changes to the portfolio this week.

A snapshot of the portfolio is as follows:

VIX Shrinkage Continues; VWSI at +6

During the week, I chronicled The Incredible Shrinking VIX, which addressed the issue of volatility falling in a market that was going mostly sideways to down. By the end of the week, the VIX was down 4.80 points or 20.6% from the previous week, to 18.47 – a level not seen since the beginning of November.

The interesting part of the week is that the SPX had a modest gain of 16.51 (1.1%), so that very little of the move in the VIX (perhaps 1.25 of those 4.80 points) can be attributed to a rise in the SPX. The rest? Some of it certainly comes from a seasonal pattern of historically low volatility around the holidays (see the CXO Advisory Group on U.S. Stock Returns Around the Year-End Holidays), but a considerable account is still unaccounted for. It looks like it may take the unfolding of events in 2008 to explain the shrinking VIX anomaly.

On the VWSI front, the shrinking VIX contributed to a new elevated VWSI reading of +6, suggesting that the VIX should be close to bottoming. Ironically, the VIX is up this morning, and so are the markets…

As is my weekly custom, for a survey of the best in current thinking about the markets, Barry Ritholtz at The Big Picture sums up the week that was and the week that will be in his Christmas Linkfest.

Finally, good news for those who are content to sit on the sidelines and wait for a more compelling market signal before committing to a specific direction, PowerShares is launching three new Buy-Write ETFs:

• PowerShares DJIA BuyWrite Portfolio (PGB)
• PowerShares S&P 500 BuyWrite Portfolio (PBP)
• PowerShares NASDAQ-100 BuyWrite Portfolio (PWBW)

These join old standbys MCN, BEP and BWV in the buy-write stable.

(Note that in the above temperature gauge, the "bullish" and "bearish" labels apply to the VIX, not to the broader markets, which are usually negatively correlated with the VIX.)

Wine pairing: For a VWSI of +6 I favor a semillon. This often overlooked varietal tag teams with sauvignon blanc to form the white wines of Bordeaux, otherwise known as Graves. The thin skinned semillon grape is particularly susceptible to the Botrytis fungus, which means that semillon is also the primary grape used in the classic dessert wine known as Sauternes.

In the New World, semillon has gained a strong foothold in Australia, where it is frequently blended with chardonnay and sauvignon blanc, but also sold on its own. Last I checked, Peter Lehmann Wines produces four different semillons, with the Barossa Valley one of the most widely distributed in the US. Skipping a little to the east, just this evening I had an excellent 2002 Alpha Domus semillon from New Zealand, but the Kiwis have yet to show the same enthusiasm for semillon that they have for sauvignon blanc. Still, the Alpha Domus effort proves that the potential is there.

It is harder to pick a particular US producer that has built a reputation for semillon, but one to keep an eye on is L'Ecole Nº 41, from the Walla Walla, Washington area. This is, by a considerable margin, my favorite non-French semillion tasted in the past 25 years, a mineraly stunner that may have you rethinking how often you should be drinking this varietal.

For more information on semillon, StarChefs.com has a good discussion of the varietal, along with a handful of recommended producers in Australia and South Africa.

How Timely Is Your News?

CurrencyTrading.net, whose last blog list included VIX and More as one of their Top 100 Day Trading Blogs, is out with a new list of note: 50 Places to Discover News Before It Goes Mainstream, authored by Heather Johnson. It is a list well worth checking out, regardless of whether or not you follow the currency markets.

On the same subject, when you think of the information lifecycle in terms of the graphic below from Monitor110, consider how important it is for your news sources to include blogs that give you new ideas to think about, long before they find their way into the mainstream media. That is part of the reason why I have a “Blogs I Frequent” list on the right hand column of the blog. If you haven’t checked that list lately, now might be a good time to revisit it, as in the past month or two I have added several excellent blogs featuring cutting bleeding edge thinking.

The Incredible Shrinking VIX

Santa Claus didn’t quite deliver the expected rally this year, but at least we got the incredible shrinking VIX. I have talked about the absence of fear on several occasions, most recently on Wednesday, but the sinkhole in investor fear has continued to expand since then. Today’s fall in the VIX all the way down to 18.65 means the lowest low water mark since the first day in November, when the VIX traded in the low 17s.

I believe Rob Hanna of The Money Blogs was the first to comment on the unusual phenomenon of the VIX following the markets down. While Rob was cautious about the negative implications of this phenomenon on the broader markets, Brett Steenbarger at TraderFeed was more open about the likelihood of an impending period of ‘subnormal short-term returns’ indicated by his research in Stocks Down, Option Volatility (VIX) Down: What Happens Next.

Adam Warner of Daily Options Report has required a little more confirmation to believe that the drop in volatility is something more than the vagaries of the holiday trading calendar, but in Volatility Dippage, it seems he has finally come around to the point of view that the VIX drop is real and not a calendar-driven oasis.

I agree that the drop in the VIX is real, but not to the extent that the VIX suggests. Here is a perfect opportunity to use the VXV, which measures volaltility 93 days out instead of the VIX's 30 day window. Per the VIX-VXV ratio chart below, the expectations of volatility over the next 30 days (VIX) are dropping much faster than those over the next 93 days (VXV). Further, if you look at the VIX futures quotes, you can see that future volatility expectations are pretty much flatlined out through the November 2008 contract, with the VIX contract prices all currently hovering in the 23 range. The bottom line: fear may be slipping a little, but it is not in a free fall, as the VIX might lead some of us to believe.

I will close with a link to a post from May in which the title tells the story: High Positive Correlation Between VIX and SPX Often Signals Market Weakness.

Gap City: LDK

I’m reasonably sure that whatever I write here will be obsolete in the ten minutes that it takes me to post it, but I feel compelled to comment about LDK Solar (LDK) anyway.

For those who do not follow LDK, this is the Chinese solar company that was the subject of accounting fraud allegations by a former controller that helped to knock the stock down from the mid-70s to the mid-20s over the course of a month or so. On Monday, LDK reported that the Audit Committee of the Board of Directors had finished their review of the matter and concluded that there had been no wrongdoing. Things were looking up until LDK reported quarterly results after the close yesterday. The numbers were generally in line, but concerns about margins and the absence of raised guidance has put pressure on this stock this morning, which traded down as much as 27% earlier in the session.

While the story is interesting, the chart may raise even more eyebrows, as it is littered with gaps and the tombstones of overzealous traders. If you are thinking about playing solar roulette, consider that directional plays are extremely dangerous. One way to make to potentially make some money off of the faddish momentum and wild gyrations is to sell volatility below support and above resistance, so you can get paid while you watch the fun. Even if you don’t play this stock, the entertainment value alone makes it worth keeping an eye on.

On a related note, is it only me, or does anyone else who trades Chinese solar counterpart JA Solar Holdings (JASO) think of a hockey mask every time they look at the ticker? Given the volatility in that stock, somehow it seems an appropriate image…

Finally, anyone interested in rolling the dice in the solar sector, Chinese and otherwise, should start their research with the excellent solar stock comparison table at China Analyst.

No Fear?

We may be stuck in a holiday time warp, but I find the lack of fear in the VIX to be more than a little surprising, particularly given the spate of gloomy headlines. I talked about this same subject three weeks ago, but the gulf between the VIX action and the news flow has grown wider and wider ever since. Is it possible that this kid has already grown up enough to get a hedge fund job?

The ISEE (below the long-term mean for the 30th day in a row) and the CBOE equity put to call ratio (spiking once again) both indicate that call buying relative to put buying is considerably below historical norms, which makes the VIX numbers even more surprising.

In times like this I turn to the VIX:SDS ratio. As shown below, my proxy for the fear premium component of the VIX is now showing a reading that is substantially below the 10 and 100 day simple moving averages. Is this merely a case of desensitization or is something else going on?

Volatility as an Asset Class I

I am beginning to believe that to some extent, this blog may be carrying the seeds of its own destruction. Specifically, the worst thing about trading and blogging about volatility is that when stuff hits the fan, the best trading and blogging setups both spike at the same time. So…if sometimes it seems to take longer for me to comment on various market action and volatility-related topics just when these topics seem juiciest of all, well it is probably a case of my trading taking precedence over my blogging.

On that note, let me open a new can of worms that I will come back to regularly and in more detail: volatility as an asset class.

There has been considerable discussion in the past few days about whether or not volatility should be considered an asset class, much of it spurred by a Barron’s article over the weekend authored by Steven Sears and bearing the title Volatility: Finally Getting Respect.

The subject of volatility as an asset class is a fairly complex one and for now I have just enough time and space here to introduce it, provide some links, and promise to be back with some analysis and opinions soon.

Before getting in to volatility, there is another perhaps larger can of worms regarding what exactly an asset class is. I am going to pass on this issue for now, other than to say that I think the Wikipedia asset class examples are an excellent way to think about the subject.

Getting back to volatility as an asset class, this subject has been discussed in some circles for at least the past five years, but the idea has received increasing media attention in the last year or two. The Financial Times was talking about Why Volatility Becomes an Asset Class in May 2006, while Hafner and Wallmeyer published an academic paper Volatility as an Asset Class: European Evidence last year that had been widely distributed in previous incarnations in 2005. Three months ago, a book edited by Izzy Nelken of Super Computer Consulting was published with the title Volatility as an Asset Class. For those who are interested, the book is available through Amazon. To get a sense of how far along this idea has progressed, Euromoney Training was recently offering a training program on the subject of volatility as an asset class.

To complete the laundry list of links, here are four excellent posts triggered by the Steven Sears article from some of my favorite bloggers on the subject of volatility as an asset class:

• ‘Random’ Roger Nusbaum – “Sunday Morning Coffee”
• Adam Warner at Daily Options Report – “Volatility as an Asset?”
• Zero Beta – “Asset Allocation Using Volatility: Is Risk an Asset Class by Itself?”
• Condor Options – “Short Volatility: The New Asset Class?”

More to follow on this subject, as soon as that pesky market volatility takes a bit of a breather…

OHFdex Getting Killed

This is how the Overripe High Fliers index (OHFdex) looked just after 3:00 p.m. ET:

Portfolio A1 Continues Strong Finish to Year

Portfolio A1 held on to most of its gains this past week and now stands up 15.7% since the portfolio’s February 16^th inception – a full 14.9% better than the 0.85% return of the benchmark S&P 500 index during this period.

While some portfolio managers may be content to dial down their aggressiveness and coast in to the end of the year with an index-beating performance all but locked up, this automated portfolio has no such feature. Instead, it will continue to try to squeeze out additional percentage points during the final two weeks of the year. Given the current state of the markets, this could be riskier than most years, but this approach also happens to reflect my personal philosophy that it is generally best to press one’s advantage when things are going well.

No matter how the chips fall, it should be an interesting last two weeks.

There are no changes to the portfolio this week.

A snapshot of the portfolio is as follows:

Lethargic Pre-Christmas VIX Has VWSI at Zero

While last week felt to most investors like a turbulent week in the markets, it must have also been a week in which the VIX was not listening to the gloom and doom reports. While the SPX fell 36.71 (2.4%) on the week, the VIX rose 2.42 points or 11.6%. Historically, when the SPX falls 2.4%, the VIX jumps about 11.4%, so last week was a typical reaction in the volatility markets, with no apparent extra fear factor in the mix. Keep in mind, however, that Adam Warner of the Daily Options Report is maintaining that the VIX is artificially low at the moment because of some idiosyncrasies in the holiday trading calendar.

So here we are, tottering on the precipice of a bear market, but with a relatively mild fear component. My bias has turned bearish, but until we start to see a pattern of lower lows, I will probably play this as more of a sideways market than a downward sloping one.

As is my new weekly custom, for a survey of the best in current thinking about the markets, Barry Ritholtz at The Big Picture sums up the week that was and the week that will be: Winter Solstice Linkfest Review/Review

I suspect that in the coming week and into the new year, headline risk will be one of the largest drivers of investment strategy. Whether you are positioning your portfolios for a potential last minute Santa Claus rally, for the January effect, or for any other strategy, consider some of the headlines you may be seeing in the next few weeks and keep in mind that one of the most important tenets of risk management is to limit potential losses.

(Note that in the above temperature gauge, the "bullish" and "bearish" labels apply to the VIX, not to the broader markets, which are usually negatively correlated with the VIX.)

Wine pairing: For a VWSI of zero, I have heretofore been recommending a variety of inexpensive blends. I recently enjoyed the 2005 Trentadue Old Patch Red, a steal at $12. Previous recommendations for a VWSI of zero have included Brassfield Serenity, as well as a wide variety of Rhone blends.

Neighborhood Home Values Holding Up Nicely

A month ago, in The Other Bubble, I mentioned that I live in Marin County, just north of San Francisco and commented on the surprising strength of the local real estate market. Well, things appear to be better than I thought.

Amidst all the talk of the subprime meltdown and impending financial calamities, I found it interesting that not too far from where I live, a house has apparently just gone into contract for $65 million – the full asking price. The Wall Street Journal broke the story this morning, but an old Forbes profile of The Most Expensive House in California is a better stop to read more about Locksley Hall, currently owned by Robert “Toxic Bob” Friedland, a global mining tycoon who earned his nickname by helping to turn Summitville Mine into one of the most notorious Superfund sites.

While I mentioned on Wednesday that I have had a good run with my trading lately, I hasten to add that I am not the buyer. So far, the buyer's name has not been disclosed. One locally famous name worth noting, however, is Olivia Hsu Decker, who handled the listing and whose web site makes for interesting browsing if you are into house envy.

Friedland has renovated the original house extensively and various sources list the current square footage at 10,000 or 12,000. I must say, however, that $6,000 per square foot is not outrageous for the area, especially considering that the views from the site are generally considered to be in the top five in the world.

If nothing else, this transaction will make for some interesting average home sale price statistics in the area. Perhaps some day I can try to sneak it in as a comp...