Any smart gambler, amateur or professional, knows that you only risk what you can afford to lose. That may be $1, $100, $500, or even a million dollars in a real estate or other major transaction. But only a fool bets the farm. Only a fool risks all.
What made so many bright minds all around the world foolishly bet the farm? One after another, that is what they did. Now we are all paying for it, some more than others. It was not just greed. It was something else.
How did this happen? I call it 'The Great Disconnect'.
When the managers of public companies do not suffer the same fate or consequences as their shareholders you have a disconnect! When politicians give lip service to understanding the pain of their constituencies but accept huge contributions from the enterprises they are supposed to regulate and oversee creating gargantuan conflicts of interest, you have a great disconnect.
When investment houses create financial instruments that are so complex that they cannot fathom the risk and the ratings agencies put candy coated frosting on them, you have a great disconnect!
Deutsche Bank and other investment banks are apparently working on plans to develop a clearing house for the credit derivatives markets, in an effort to allay rising regulatory concern and investor skittishness about counterparty risk, The Financial Times reported Friday.
Deutsche Bank (NYSE: DB) and other banks are apparently trying to develop a plan that would allow only institutions with strong capital bases and credible trading histories to clear trades in the credit default swap markets with a central counterparty, The FT reported.
The derivatives market has experienced explosive growth in the past decade, with the instruments' value totaling $350-$450 trillion, depending on the methodology used. At the same time, the credit default swaps market has grown to $45-50 trillion.
Global clearing house
Economist David H. Wang told BloggingStocks Friday that, ideally, a global derivatives clearing house should take the form of a public, international organization administered by member nation states. Failing that, he'd like to see a private international organization administered by the major investment banks.
You can add another item to the list of things the market has to be worried about.
In this month's Portfolio magazine, Michael Lewis wonders if the Black-Scholes formula -- the formula used to calculate and manage risk throughout the financial world, including determining the risk of trade positions and hedging strategies -- is flawed.
The Black-Scholes formula is an advanced mathematical formula generally credited with revolutionizing options pricing. Its assumptions are the basis for short trades and options designed to protect a trader against losses, no matter how much the market falls.
However, as Lewis outlines, while the formula has been good, it is not perfect, as evidenced by the October 1987 stock market crash, when traders and institutions learned that even with Black-Scholes techniques deployed, when the market is crashing and no one is willing to buy, it's impossible to sell short. The outcome? On "Black Monday," the Dow Jones Industrial Average plunged 508 points or 22.6% on October 19, 1987.
Robert J. Shiller's Irrational Exuberance is the classic book for understanding the stock market bubble of the late 1990s and early 2000s. His contribution to the study of real estate is equally compelling. The House Price Index used to track our real estate market was co-developed by Mr. Shiller -- and is innovative in that it adjusts for the quality of homes involved in transactions.
So given his expertise in bubbles and real estate, he is probably the guy to listen to when it comes to the topic of the real estate bubble.
In a column in this Sunday's New York Times, Shiller gives an interesting possible explanation for a question that hasn't gotten a lot of attention: Why were Alan Greenspan -- and a lot of other presumably intelligent people -- unable to see that real estate bubble for what it was given that, in retrospect, it seems so obvious?
The answer may lie in a psychological phenomenon known as information cascade. Be sure to read Shiller's column for an explanation of how this may have applied to the real estate market. It's fascinating stuff.
And understanding why the bubble wasn't widely detectable is key to understanding why it happened. As Shiller writes, "The failure to recognize the housing bubble is the core reason for the collapsing house of cards we are seeing in financial markets in the United States and around the world. If people do not see any risk, and see only the prospect of outsized investment returns, they will pursue those returns with disregard for the risks."
Now that the Dow has fallen 10% from its October 2007 peak of 14,164 to 12,743 -- i.e. now that it officially qualifies as a correction, it's a good time to summarize the investment landscape, fundamental and technically.
Although numerous fundamentals (high energy prices, subprime mortgage defaults and subprime-asset losses, housing sector slump, slowing U.S. consumer spending) suggest U.S. economic growth will slow up ahead, and hence that more selling is ahead for the Dow, that, in fact, may not be the case.
If limited to roughly 10%, the Dow's decline constitutes solely a correction. Keep in mind also that the Dow is a lead indicator that always points to economic conditions 6-9 months ahead. Hence, investors, if they believe that measures being taken are addressing important concerns, could conclude that economic conditions will improve and hence send the Dow rising very soon.
WM is recently trading at $34.96 in pre-open trading, below its close of $35.28.
WM says: "Weakening housing market and disruptions in the secondary market through the end of the third quarter will result in a decline in net income of approximately 75% from the prior quarter."
WM will announce full EPS on 10/17.
WM overall option implied volatility of 35 is above its 26-week average of 30 according to Track Data, suggesting larger price fluctuations.
Merrill Lynch (NYSE: MER) is recently trading at $73.70 in pre-open trading, below its close of $74.78.
MER says: "Challenging credit market conditions will have an adverse impact on its net earnings for the third quarter. The company expects to report a net loss per diluted shares of up to $0.50 cents, resulting form significant negative mark-to-market adjustments."
MER October option implied volatility of 44 is above its 26-week average of 30 according to Track Data, suggesting larger risk.
Daily options Update is provided by Stock Specialist Paul Foster of theflyonthewall.com
You currently don't have to ask too many Americans about economic conditions in order to get the impression that at least here at home a majority of people sense that economic upheaval is quite underway. The word recession is becoming a bit too commonplace for my taste and I have come across more than a couple references to "the coming pandemic." I myself wouldn't go so far as to predict widespread economic collapse, but I have called the current economic environment a "realignment" and I hold with that assessment.
In light of our volatile economic times I thought it might be a good thing to do a quick piece about risk assessment. I have suggested that now is the time to cut risk to the bone; I still hold to that. The theory is that the greater risk you take the more you should be rewarded for taking that risk. My position is that currently our high risk economic environment will not, except in a few scattered cases, provide adequate return for the risks involved. In my opinion the risk curve is temporarily broken and I suggest holding the bulk of your money away from high risk play.
McAfee (NASDAQ: MFE) volatility of 39 above 26-week average of 30. MFE, an intrusion prevention and security risk management provider, is recently up .22 to $33.75. MFE over all option implied volatility of 39 is above its 26-week average of 30 according to Track Data, suggesting decreasing risks.
Symantec (NASDAQ: SYMC) over all option implied volatility at 36. SYMC provides solutions to help individuals and enterprises assure the security and availability of their information. Soleil Securities says "we are reiterating our SYMC Buy rating and our $27 price target." SYMC over all option implied volatility of 36 is above its 26-week average of 33 according to Track Data, suggesting slightly larger risks.
Websense NASDAQ: WBSN) implied volatility of 42 above 26-week average of 32. WBSN, a web security and web filter software company, has a market cap of $907 million with zero long term debt. WBSN reported total 2006 revenues of $178 million. WBSN is recently down .02 to $19.97. WBSN over all option implied volatility of 42 is above its 26-week average of 32 according to Track Data, suggesting larger price risks.
Aladdin Knowledge Systems-(NASDAQ: ALDN) implied volatility Elevated at 39. ALDN is a global provider of security solutions that reduce software theft and protects network users from undetected spam & viruses. ALDN has market cap of $298 million with zero long term debt. ALDN reported 2006 annual total revenue of $89 million. ALDN over all option implied volatility of 39 is above its 26-week average of 33 according to Track Data, suggesting larger risk.
Volatility Index S&P 500 Options-VIX down 1.61 to 28.38.
Daily options Update is provided by Stock Specialist Paul Foster of theflyonthewall.com.
The sub-prime mortgage market is in shambles. But Wall Street, making every effort to rid itself of risky mortgage-backed securities, has found a new group of potential buyers -- university endowments.
The Wall Street Journal reported (subscription required) that university endowments have started to dip into the risky world of buying sub-prime mortgage debt. An opportunity recently stemmed from two money-losing hedge funds at Bear Stearns (NYSE: BSC), and one that required loans from various banks to halt the seizure of the fund. Merrill Lynch & Co. (NYSE: MER) a lender to these funds, auctioned some assets it had seized from Bear for $850 million. However, the auction sold for less than half that amount, according to people familiar with the matter.
Lou Morrell, vice president for investments and treasurer at Wake Forest University in Winston-Salem, N.C. is quoted as saying he sees value in those auctions. "There's an opportunity out there to buy these loans at a discount," he told the WSJ, and that "will be popular with a lot of endowments out there." The university is placing $25 million of its $1.2 billion endowment with a hedge fund to invest in sub-prime mortgages.
They're not the only ones dealing in big risk either.
Pogo Producing Co. (NASDAQ: PPP) volatility and share price spike on strategic alternatives.
PPP is engaged in oil and gas exploration, development, acquisition and production activities.
PPP announced in its earnings release on 4/24 "that its strategic alternatives process, which includes the possible sale or merger of PPP, the sale of its Canadian or other significant assets, and changes to the company's business plan, is ongoing."
PPP is recently up $3.92 to $52.47. PPP call option volume of 2,746 contracts compares to put volume of 1,090 contracts. PPP May option implied volatility of 40 is above its 26-week average of 30 according to Track Data, suggesting larger price risks.
Armor Holdings (NYSE: AH) implied volatility suggests Flat risk as AH at record High
AH, a manufacturer of tactical wheeled vehicles, has a market cap $2.5 billion with long-term debt of $419 million.
AH reported 2006 annual revenue of $2.3 billion. AH is recently up $1.31 to $73.39.
AH overall option implied volatility of 29 is near its 26-week average according to Track Data, suggesting non-directional risk.
Amaranth Advisors was a hedge fund, so it's not a big deal that it collapsed because of hugely speculative bets on the direction of natural gas prices. While it was a rare collapse because of its size, these funds come and go all the time. But Bank of Montreal reported today that it lost around $404 million making similar bets on energy. Aren't banks supposed to be conservative? Hey risk management guys (Ben Stiller in Along Came Polly), where were you on that one?!
Here's what the company's CEO said about it on the conference call: "The loss that we announced today is outside our tolerance."
Oh, OK. Have you noticed that unexpected volatility and wild swings seems to happen a lot -- more than the experts say it should? And that large one-time events seem to have a greater impact than the day to day occurrences, but we focus most of our energy on the mundane rather than the rare? I just finished an excellent book called The Black Swan: The Impact of the Highly Improbable by Nassim Nichola Taleb. In it, Taleb explores the impact of the unforeseeable on the course of life and history, and refers frequently to the financial markets -- he was once a derivatives trader. It may seem dry in parts and is probably not for Jim Cramer fans, but it's one of the most intelligent books with applications to investing that I've seen in a long time.
Cypress Bioscience Inc. (NASDAQ: CYPB) option implied volatility above 200 suggests Risk into Data. CYPB closed at $7.66. Data from CYPB's end PII Milnacipran (Fibromyalgia Syndrome: FMS) trail, is expected to be released before mid-year. CYPB June option implied volatility is above 200 according to Track Data, suggesting large price fluctuation risk.
South West Energy Co. (NYSE: SWN) implied volatility suggests less Risk as SWN at record High. SWN, an energy company focused on natural gas, closed at $44.35. SWN has a market cap of $7.5 billion with long term debt of $136 million. SWN reported 2006 annual revenue of $763 million. SWN is expected report EPS on 5/1. SWN May option implied of 38 below its 26-week average of 46 according to Track Data, suggesting decreasing price risks.
Daily Option Update is provided by Stock Options Specialist Paul Foster of theflyonthewall.com.
Clear Channel Comm (NYSE: CCU) -- options priced as if shareholders will approve $37.60 buyout. CCU struck a deal to sell itself for $37.60 to Thomas H. Lee Partners and Bain Capital LLC in November of 2006. Two-thirds of CCU shareholders are needed to vote for the deal on 4/19 for the sale to be completed. CCU options are active today. CCU April 35 calls are priced as if CCU will be trading at $36.40 by 4/20. May, July and October are priced as if two-thirds of CCU's shareholders will approve the $37.60 sale.
Comcast (NASDAQ: CMSCK) -- option implied volatility suggests non-directional Risk into Rally. CMCSK is recently up $1.03 to $27.29. Bloomberg ran a story with a headline of "Comcast Chief Roberts says his business is 'On Fire'." CMCSK overall option implied volatility of 24 is near its 26-week average of 23 according to Track Data, suggesting non-directional risk.
The Volatility Index for S&P 500 Options (VIX) is up .16 to 13.62.
Cypress Bioscience (NASDAQ: CYPB) -- option implied volatility Elevated at 194. CYPB closed at $7.46. Data from CYPB's end PII Milnacipran (Fibromyalgia Syndrome; FMS) trail, is expected to be released before mid-year. JEFF has a Buy on Attractive Risk/Reward with a $14 price target on CYPB. JEFF says "our diligence with investigators and statisticians increase our confidence in the prospects for a positive outcome." CYPB June option implied volatility is at 194 according to Track Data, suggesting large price fluctuation risk.
Starwood (NASDAQ: HOT) -- implied volatility suggests Flat risk; HOT at Record price on Chatter. HOT, a leading hotel and leisure company, is frequently mentioned as a private equity break up-recapitalization candidate. HOT is up $1.13 to $70.97. HOT's CEO Steve Heyer resigned on 4/12/07. HOT will announce EPS on 4/26. HOT has a market cap of $16 billion with long term debt of $2.3 billion. HOT reported 2006 annual total revenue of $5.9 billion. HOT May option implied volatility of 26 is near its 26-week average according to Track Data, suggesting non-directional risk.
The Volatility Index for S&P 500 Options (VIX) is up 1.33 to 14.28.
Option volume leaders today are: Apple Computer (NASDAQ: AAPL), Tesoro (NYSE: TSO), Oracle (NASDAQ: ORCL) and Microsoft (NASDAQ: MSFT).
Dendreon (NASDAQ: DNDN) straddles the expensive rating on heavy volume, suggesting Large Risk. DNDN, a biotechnology company focused on the discovery, development and commercialization of therapeutics that harness the immune system to fight cancer, is recently up $.57 to $5.03. DNDN's lead drug Provenge (for treatment of asymptomatic, metastatic, androgen-independent prostate cancer) has a Prescription Drug User Fee Act (PDUFA) review date on May 15th. DNDN call option volume of 15,831 contracts compares to put volume of 14,850 contracts. The DNDN April 5 straddle is at $3.20 and the May straddle is priced at $4.05, suggesting large price risk.
The Daily Option Update is provided by Stock Options Specialist Paul Foster of theflyonthewall.com.
Any smart gambler, amateur or professional, knows that you only risk what you can afford to lose. That may be $1, $100, $500, or even a million dollars in a real estate or other major transaction. But only a fool bets the farm. Only a fool risks all.
Now that the Dow has fallen 10% from its October 2007 peak of 14,164 to 12,743 -- i.e. now that it officially qualifies as a correction, it's a good time to summarize the investment landscape, fundamental and technically. 
You currently don't have to ask too many Americans about economic conditions in order to get the impression that at least here at home a majority of people sense that 
The sub-prime mortgage market is in shambles. But Wall Street, making every effort to rid itself of risky mortgage-backed securities, has found a new group of potential buyers -- university endowments.
Pogo Producing Co.
Cypress Bioscience Inc.
Bush administration ignored regulators' warning of mortgage meltdown
Cramer on BloggingStocks: Any downside should now be muted 
Citigroup bailout sheds light on just what the taxpayers are buying
