January 8. This is EASY!

The following is from a Stan Druckenmiller speech on January 18, 2015.  His comments are fascinating, but I am simply using this small excerpt to make a point.  I have included the link to the entire speech  below.

After about a year and a half – I was a banking and chemical analyst – this guy calls me into his office and announces he’s going to make me the director of research, and these other eight guys and my 52 year old boss are going to report to me.  So, I started to think I’m pretty good stuff here.  But he instantly said, “Now do you know why I’m doing this?” I said no.  He says, “Because for the same reason they send 18 year olds to war.  You’re too dumb, too young, too inexperienced not to know to charge.  We around here have been in a bear market since 1968.” This was 1978.  “I think a big secular bull market’s coming.  We’ve all got scars.  We’re not going to be able to pull the trigger.  So I need a young, inexperienced guy.  But I think you’ve got the magic to go in there and lead the charge.”  So, as I told you he was a maverick, and as you can already see, he’s a little bit eccentric…

The other thing he taught me is earnings don’t move the overall market; it’s the Federal Reserve Board.  And whatever I do, focus on the central banks and focus on the movement of liquidity; most people in the market are looking for earnings and conventional measures.  It’s liquidity that moves markets.

…here’s where the dumb luck came in in terms of my investment philosophy.  So, right after he leaves, the Shah of Iran goes under.  So, oil looks like it’s going to go up 300%.  I’m 25, I don’t have any experience.  I don’t know anything about portfolio managers.  So, I go well, this is easy.  Let’s put 70% of our money in oil stocks and 30% in defense stocks and let’s sell all our bonds.  So, and I would have agreed with him if I had some experience and I was a little more experienced, but the portfolio managers that were competing with me for the top job, they, of course, thought it was crazy.  I would have thought it was crazy too if I’d had any experience, but the list I proposed went up 100%.


The first week of the year has closed out.  Friday to Friday changes in many markets were modest, though stocks marched merrily higher.  The notable change over the week was a tilt toward a flatter curve in the US. There were substantial bets made late in the week indicating that the Fed may be prodded into tightening quicker than expected.  On the week, the 2 yr yield rose 2 bps, while 5’s were essentially unchanged, tens -1.7 and 30’s -5.1.  Supply in tens and thirties this week.

Implied vol in the front Eurodollar contracts firmed relative to the backs as predicted by an astute option trader, who, in positing this theory a couple of weeks ago, had noted considerable near term uncertainty including Fed policy, Trump, European elections, etc.  He thought a price of 14 in the EDM7 9875 straddle was ridiculously low (it settled at 16 Friday) and that EDU7 9862 straddle at 23 was also wrong (ditto, settled at 24).

Friday’s employment release wasn’t too far off expectations, but since yields had generally eased over the previous week, the market read the report bearishly.  Sometimes, it’s just this easy:  Hourly earnings in the employment report were +0.4, faster than expected bringing the yoy rate to 2.9%.  Prices paid component of Mfg ISM was 65.5, highest since 2009 (released Tuesday).  On Thursday we had non-mfg prices:  ”The Prices Index increased 0.7 percentage point from the November reading of 56.3 percent to 57 percent, indicating prices increased in December for the ninth consecutive month at a slightly faster rate.”   M2 is growing at 8%.  Let’s not make this more complex than it is.  We’re at full employment and the other pieces of the puzzle have fallen into place, higher wages and prices with the FF target just slightly off historic lows.  And Trump’s new top economic adviser (Goldman’s) Gary Cohn had this to say in a recent WSJ interview.  “We will never have those real conversations, but if we woke up tomorrow and every central bank in the world raised their interest rates by 300 basis points, the world would be a better place. “

Now imagine an inexperienced Rip van Winkle who falls asleep in 1994 and wakes up now.  He looks back for historical clues.  Back to 1993, just before an aggressive hiking cycle, to see how the data compares with now.  1993 GDP: Q1 0.8, Q2 2.4, Q3 2.0 and Q4 4.5.  How about 2016: Q1 0.8, Q2 1.4, Q3 3.5, Q4 2.9 (Atl Fed GDP Now estimate).  Pretty close.  What about CPI?  1993 2.97, 2016 1.7.  OK so where did FF target start?  In 1993 it was 3%, and 1 ¼ year later, topped at 6%.  What is this inexperienced kid going to do?  CHARGE!!  Buy all the puts he can!  This is easy.

Of course, the world isn’t the same place.  My personal view is two hikes in 2017 (because I am ‘experienced’ and ‘scarred’).  From a hedger’s standpoint however, protecting against a suddenly aggressive Fed isn’t all that expensive.  For example, during the day Friday I put out this comment:  EDZ6 settled near 9900 or 1% libor.  What if the Fed were to hike once a quarter?  Look at buying this strip…  EDH7 9887p, EDM7 9862p, EDU7 9837p and EDZ7 9812p as a strip for 14.0 bps.  Simplistically, if the market expected 25 bps per quarter, then each of these strikes would settle 12.5 in the money.   Friday settles: EDH7 9887p 3.0s, EDM 86p 3.25s, EDU 83p 3.5s, EDZ 81p 5.5s.  Total 15.25.

Now let’s get back to Friday’s action, and this note is a bit more specific about particular option trades than most…might get a bit bogged down here.  There has been significant put buying in near Eurodollars, which accelerated late Friday.  Recent large buys have been EDJ (April, EDM7 underlying) 9862/9850 put spreads 1.0 to 1.5.  EDZ7 9825/9800 put spreads for 4.5 to 5.0.  Friday there was heavy buying of April and May 9862.5 puts vs selling 9900 calls.  In April it was mostly done for 0.5 and 0.75 bp and in May, -9900c, +9862/9850p 1×2 for 0.5.  Final settles and open interest changes are on the table below.  The point is, heavy, but relatively inexpensive bets are being placed for a hike in March with possibility of another in June.  EDJ 9862p/9900c risk rev settled 1.5, and same in May 2.0. Total Eurodollar future open interest rose 240k in confirmation of the bearish price action.

I also included February TY puts that have been accumulated in size, the 123.5, 123 and 122 strikes.  One full point in the ten year futures is worth 12.5 to 12.9 bps currently, so as of Friday’s settlement of 124-13, the 123.5p is about 11.6 bps out of the money, reference cash yield of 2.416% (so 123.5 strike should be ~253).  As a reminder, tens and thirties are auctioned Wed and Thursday, and Retail Sales are on Friday.




EDJ 9862p 2.00 0.50 160k 62.3k 4/13/2017
EDJ 9900c 0.50 -0.50 87k 49.0k 4/13/2017
EDK 9862p 2.50 0.50 118k 91.3k 5/12/2017
EDK 9850p 0.50 0.25 118k 90.6k 5/12/2017
EDK 9900c 0.50 -0.75 91k 91.0k 5/12/2017
TYG 123.5p 19 4 80k 22k 1/27/2017
TYG 123.0p 12 2 142k 17k 1/27/2017
TYG 122.0p 5 0 121k 1k 1/27/2017
Posted on January 8, 2017 at 2:06 pm by alexmanzara · Permalink
In: Eurodollar Options

Leave a Reply