SharperDingaan

"There is a place for options (ie: hedging your employment with puts on a competitor of the company that you work for) but it should be a fairly rare event". Some explanation: Virtually all employers treat employee hedging (of their stock) as a firing offence - but it is illegal to prevent an employee from buying puts on a competitor. The typical arrangement is a Memorandum of Understanding, monthly statement disclosure, long ABC coy employee options, and short XYZ coy via the put. You agree to bleed a little every quarter, to make a profit if XYZ coy experiences difficulties - identical to Taleb. Assume that you worked for a Cisco, & per common practice you're awarded 40% of your salary in options. If Cisco does well you will too, but because its a big part of your comp you don't necessarily want it adversely exposed to the market. Nortel is a direct competitor, & pretty much the same business conditions that affect Nortel will affect Cisco, & about the same time. Therefore buy the equivalent number of Nortel puts. Everybody keeps buying tech, the earnings & stock price are up, & Ciscos bonus cash rains upon you. The cash bleed is easily affordable & the puts get rolled up & out to minimize the decay loss. But when everybody stops buying ... Ciscos earnings & share price drops, & it pushes the sectors multiple downward, affecting Nortel. The sectors share prices go into a feedback spiral, & all those employee options go into the toilet. If it spirals long enough; there are eventually mass layoffs, asset sales, & potentially bankruptcy. Except that you got to stay rich because you were hedged, & those same conditions have driven your puts very deep into the money. You also have the exchange as your counterparty, vs someone else in the industry who may not be able to pay. .. And if the scale is big enough, pehaps you even have enough to take out some of those assets ! Old skule WEB

70% of options expire worthless, & most of the other 30% simply breaks even. Worse still is that for every big ‘win’ with a 5-10% P(x) of occurring, you need the win to be at least a 5 bagger just to recover your losses. You sell options – you don’t buy them. A call option is simply a mechanical limit order – so why are you paying someone else to do what you can already do very easily ? And if you already have the cash to buy at ‘X’ - isn’t the return that you’re paying really the premium x 12 months/option period x 70% + the 12 month T-Bill rate. There is a reason to the madness. The best option is often the longest dated option, but you can’t borrow against any interim ‘gain’ & its not liquid if it goes deep in the money. If you’re long the underlying you can do both, & you still have time to bail you out if the price falls the day after you buy. There is a place for options (ie: hedging your employment with puts on a competitor of the company that you work for) but it should be a fairly rare event. Not text book SD

Re Stingy Investor. 'Marketing' returns significantly different from client returns should throw up a bunch of red flags. It can only happen if the 'market' portfolio is either investing materially differently (holding period, asset mix, securities, fortunate timing, etc.), or the advertised portfolio return itself is false. One lacks 'truth in advertising', the other just lacks truth overall. SD

Had an interesting discussion. It turns our that when you ask a Cdn lottery ticket buyer what they would do if they won big, a significant number say that they would continue to work - but on a reduced time basis. The reasons cited being mental stimulation, friends, feeling of worth, etc. What do others think ? If you work 3 days a week, you're effectively voting with your feet - & asserting that the activity (you could work for any employer, not just your current one) has a 60% (3 days in 5) societal value to you, & a 40% (2/5) monetary value. The annualized equivalent is work 7 months/yr (60%) & take 5 months (travel over winter, visit family etc.) off (essentially the 'contract' model of employment). What do others think ? The design 'retirement' age for most pension plans is roughly 65 (Canada Pension Plan). But the reality is that it is age discriminatory & that you can't actually force retirement - you can only pay more/month if the participant retires later, & less if they retire earlier. Here is the rub: If a pension acts like a personal lottery would most people want to continue working either part-time, or on a 'contract' basis, for a couple of years post retirement ? If the answer is 'yes' - you need substantially less retirement capital as you're earning what you're spending, & when you do 'retire' you'll get paid more/month because you deferred the payout. What do others think ? The answer has some major implications; - State social program changes (Employment Insurance, Child Care, Pensions, etc) - Societal 'norms' change ('age culture' vs 'youth culture', long term health, child care, etc.) - Employment practice (full-time/part-time/contract mix, attitudes, work force integration) - Wealth Mgmt restructuring (advice vs transaction bias, product, shorter horizons) What do people think? SD

You can take on Cdn real estate risk essentially 4 ways - 1) Chartered Banks as mortgage originators, 2) Life Coys as the buyers of long term commercial mortgages, 3) Ppty Mgrs as building investors/managers, or 4) REITs. Moving from 1) to 4) reduces BOC influence, & multiplies the inherent business risk. It is reasonable to assume increases in Chartered bank provisioning (commercial loans, credit cards, etc), but will it reduce overall profitability with enough certainty to bet on it ? And why is the REIT not the better bet ? Then keep in mind that a ppty manager has an incentive to buy a REITs building, issue the property management contract to itself, & repo the building back to the REIT - with all of it at a rising price. Everyone shows gains, all the buildings get marked to these new prices, & the incentive is strongest when the times are toughest. The bank franchises are extremely strong, deep, & protected. Handle with care SD

He doesn’t necessarily need to sell CAD & buy USD. The smart way to ‘quantitatively ease’ is to fund something massive (ie: nation-wide state-of-the-art green energy infrastructure, buried & super-cooled electric transmission lines, replacement of the power grid, etc.). Very big $ commitments too big for any one or group of provinces, a clear & lasting national interest, & spending sizeable enough to have a material impact on inflation. Then bear in mind that the BOC is legally required to maintain inflation at an orderly rate, would be paying roughly 2% of GDP/year in newly printed CAD notes, & that only the BOC is in a position to control the inflation. No wonder the governor is smiling. No one is going to want to buy CAD unless they have to pay for something, which will drop the currency in a big way - & keep it there. A CAD manufacturer is also not going to export without a solid LC backing the receivable, as he can divert production domestically. Unlike depreciation this is building real & long-term assets, & Canada ends up with both a stronger economy & currency. Very elegant. SD

Keep in mind what wasn't in that analysis (mortgage amortization, mortgage premium income, etc.), & where the analysis originated. The risk is with CMHC (federal government), not the Cdn Banks. The ticking bomb is really the UK commercial property market, as the mortgages (trillions) are coming due in 2009/10/11 at a time when there's zero interest. There will be a rush to foreclose untill the upfront loss exceeds the additional cost on regulatory capital on carrying the deadbeat credits. Being first past the post will have a very real advantage, so expect rapid price erosion. The UK issues will quickly spead to Europe & then the US/Canada. The forced additional commercial mortgage provisioning could well do a number on bank earnings for a good 9-15 months. SD

Keep in mind this is before the Q2 earnings come out. 06/30/2009 debenture interest was paid in cash. 12/31/2009 and 06/30/2010 debenture interest will be paid in shares if there is a material drop in the level of cash on hand. Nothing unexpected. St Felicion will be financing maintenance CapEx from Black Liquor subsidies - which is much more significant than it might seem. Reluctant to suggest more, as we’d prefer not to steal managements thunder. Assume interest will now be roughly 5% on about 166M of CAD equivalent debt – 8.4M/yr. The bankers are agreeing to add this to the debt, & capitalization will increase net earnings by approx 9c/share over the next 12 months. Again more significant than it seems, & we’d rather that management spoke to it. There is an inference, & a growing incentive, to do some kind of equity issue or debt/equity conversion from 07/01/2010 onwards. Reluctant to suggest more but worst case, the debs get repaid in shares when they mature 12/31/2011 All in all, far better than we might reasonably have expected. Management is pretty much earning their pay this year! SD

Always remember that a trader is just an opinionated salesman, but to be a really good salesman you also have to be a sociopath. I am the center of the universe, because I am the best at what I do, I prove it everyday, & all others bow before me. But every trophy wife knows otherwise. 1) Our trader is only good if everyone else chooses to play his game, his way – which is why there’s a rant every time the game changes. 2) Yes our trader really is good; but only so long as his game lasts, & it can’t last forever. So flatter, push, destabilize, & get as much as possible – now. Before he blows up. 3) Her best trade is to short. Get paid from the blow up, & get paid again from the divorce - but to get the timing right you have to stay near him. Taleb’s continuous hedge strategy is a bet on 3), & that it happens every 4-7 years or so. Human nature would seem to ensure that he’ll pretty much always get it SD

25% FI, 20% Equities, 45% Cash, 10% Options. High cash as we’re short puts & are waiting on earnings reports. If we get what we'd like, we will very quickly be negative cash. Happy hunting SD

CIT has just demonstrated that the fed is now letting players go. Given the hard evidence that stimilus spending has now taken hold, & the discussion of 'exit strategies' - one or two failures is actually desirable. Q2 bank earnings are dangerously skewing the market. Deduct interest for the interest free TARP funds, & write-down marketable securities by 10-15% for the 'funny' valuations - & the real position is hugely different. The cleanest way to 'exit' is to issue T-Bills (repaid TARP funds buying bills) & start putting interest expense on the bank P&L. The Cdn regulatory system has been repeatedly held up as a 'guiding' model. Banks require a licence (charter),the ongoing operation is at the discretion of one authority (ie: the pleasure of her majesty), and you get a government sanctioned monopoly. You do as your told or the authority triggers a run on your bank, there are no precedents/appeals/regulations - just 'her majesty is displeased'. Applied to the US, & its goodbye lobbying. The fed/treasury isn't 'protecting', they're simply preparing the next steps SD

Keep in mind that much of the Wall Street 'news' is just posturing. Conveniently ignoring the fact that the frat boys have screwed up so badly that they've lost the franchise, & its not coming back.

FFH is simply being very swift. If they do nothing they will lose their investment but if they keep it alive (1) they will eventually take out a truly extraordinary return (2) they will always have prefered access to all future forestry deal flow & (3) there is little competition, & the additional risk they take on now is relatively small for what they get. The real money is when this industry gets restructured, & that has always been the premise behind their forestry/pulp investments. Long term business decision. SD

Makes a lot of sense but small steps first. Poll for the direction of the major macro variables (inflation, currency, economy, etc) 6 months out - & divide by region: NA, Asia, Europe, etc. SD

Gold is simply the elected hedge against the anticipated change - it could just as easily have been oil. The assumption is that central bankers will use gold as their 'store', because that is the history - & everybody can buy gold. The reality is that central bankers also have the SDR (Special Drawing Right) which functions a lot better than gold in almost every regard - & nobody but a central banker can get them. China pushed hard at the recent G8 for USD reserve status (store of value) replacement with the SDR. As the worlds creditor, & a trading partner with a currency pegged to the USD, the inference was clear. China's USD reserves shift into SDR, & the currency gets pegged to SDR vs USD. Yuan effectively becomes the new reserve currency - as it is the only currency backed by SDR . Goodbye gold Looking backward isn't going to help anyone here. SD

GE is a great buy, but the real money is 3-5 years out once all the write-dwns have cleared its BS. Over the next 12 months they may well come down some more, but long-term the future looks bright. Risk mitigation requires that a investor roll into his/her position over time - vs buy the whole thing right away. The reality is that a large chunk of GE's BS was financed with short-term $; they had difficulty rolling it, & had to go to longer terms with higher rates. The good news is that they were able to roll at the lowest available global rate, the bad news is that their various BU ALM's are no longer optimal. Earnings drag from penalty interest. GECapital is a platform, sourcing funds at the lowest possible global cost of funds; take it away & the other BUs will be far less profitable. More penalty interest & less margin as financing/lease sales evaporate. A value investment, with significant trading opportunities attached. SD

What's not in here, & what all these quants missed is the very high model risk in this strategy. For Taleb to win he needs to able to sustain a cash bleed every day, & then periodically collect big from a wide range of people when there's a market discontinuity - every few years. Academically correct. But .... In the real world he's really betting against very few people (one), & hoping that when the payoff event happens those people can pay up the cash immediately - ignoring the proven reality. He's really short cash & long a long-term unsecured low quality note - if the event itself doesn't first put the counterparty under. Very similar to having AIG as your counterparty on the other side of your CDS trade. SD

Cadboard: Agreed the 'it can never go down sentiment' is built in, but recognize that it's also a time horizon thing. Long term, if the BOC maintains inflation at 2% for 25 yrs the house will sell for 64% ((1.02)^25)-1 more than it will today. Add in a 25yr mortgage amortization & the homeowner is understandably going to feel 'rich', because the house is really a long term savings plan paying you inflation + free accommodation Short term, its an investment that can go either up/down. Buying to fix up & flip to really no different to momentum investing - you just think you know better because you did the work & therefore have some degree of 'control'. Buying in tough times, or when rates are high, is no different to buying a bond & waiting for an upgrade. Different geographic areas will have different preferances, & threfore orientation. To a large degree Vancouverites are pricing in potential gains from renting out during the olympics, and/or selling to others who will use the property as 'cheap' accommodation - no different to Cape Town, RSA with the Soccer World Cup. But Vancouver also has a significant asian buying population which is much more risk tolerant, & access to HK $ which is even more risk tolerant - especially if there is a also a son/daughter on Cdn soil to manage the property. Someone in Halifax, Ottawa, or Edmonton might find that horrifying (less risk tolerant), but those are also long term property holders - so price swings are generally not going to be as extreme as there are fewer risk takers (who need to sell) in those markets. On balance the 'it can never go down sentiment' does exist, but it would seem to be a lot better controlled. Real world diversification that actually works for a change! SD

Keep in mind that the US market went down in large part because securitizers couldn't continue to fund, & walked away. These low DP mortgages are being funded by the BOC through pass-through selling by the major banks. There is relatively low risk, these are amortizing federally insured mortgages (systemic risk is contained - & lowered every time a monthly principal payment is received), & the properties are generally being bought at lower prices than would otherwise occurr were the market in a more 'normal' state. There is only 1 funder, they know exactly how much of this funding is out there, its maturity term, the geographic markets where the funding is, & the % of each market that the $ represent. Very different from the US. SD

Look at the major banks in the area, & sell out-of-money puts with a view to acquiring the underlying. An ivestor might rationally accept the states IOU at a discount because they're expecting a fed bailout, but nobody is going to accept a munis IOU. When the first muni 'hits the wall', financing will close on all them - & the balloon goes up. Either the fed covers the munis directly (unlikely, as it would have to be for every muni in the country), or they cover the muni by directing $ through the state (more likely). Given the states frozen budgetary decision mechanisms, most would count on perhaps 2-3 months for the $ to actually reach the muni. Property values, especially heavy muni services uses (commercial) could expect a temporary hit, which will hit the banks. Geographic concentration, & media hysteria, will make those hits harder. Temporary additional TARP funds to cover the banks liquidity drains, will add fuel - & all bank stocks will trade lower. But ..... it's temporary, as this whole event is only because the state can't make decisions - & that is a relatively easy fix. The major banks in the area end up stronger than they were going in. Not great if you live in this state, but an opportunity if you can tolerate the volatility. SD

If some of those friends think he's talking he's going to have a very short life.

Cheer up, We could all be getting a zillion units (7% dilution) tomorrow at $.22, if the debs pay their interest in PIK ! SD

Agreed there is no 'right' way, & to each his own. Worth noting is that if you sell the underlying & simultaneously buy a long dated call at the market, you get the best of both worlds provided the stock is volatile. At best, either up or down, you lose the premium - which is what you'd expect when buying insurance. Also note this is a trading strategy relying on volatility (not Mr Market selling inopportunely), that works because IFRS accounting drives BV volatility - & P&C's typically value at a BV multiple. Returns are higher than they would otherwise be, but its a trading gain/loss on top of the IV gain/loss. Not for everyone, but something to keep in mind. SD

Been doing something similar for a very long time. That said: (1) Cash is not earning nothing; its also earning you the opportunity gain x the P(x) of the adverse event occurring. You are seeing only the tip of the total return. (2) Reinvesting the cash immediately is doubling risk - unless you're absolutely certain that the investment will immediately move up if your adverse event occurrs. No one can be that certain. (3) This comes from arbitrage & the pressure to 'keep the cash working'. As in the martial arts; redirect vs fight that pressure & you emerge smelling like roses. SD

Couple of critical things being missed: We (this board) may value based on fundamentals & patience, but the market doesn't. Momentum $ flowed in because the realized CDS gains were huge & sexy - they flowed out when players realized it was a one-time thing & a FFH investment became perceived as 'dead money'. We are approaching the riskiest part of their year (hurricanes) & we have an AIG in the marketplace sitting out there with an open (federal) wallet should it turn out to be a bad UW year. Most would be hedging their downside, & inherently limiting the upside over the short-term. Most investors want quick & easy: P/E multiple x fairly reliable earnings (with upside surprizes). But with P&C coys a large portion of the market values at BV multiples - & for very good reason. Deep dive vs surface fluff. Todays accounting magnifies BV volatility, so dissapointment is almost enivitable - exaggerating price swings. Most would expect FFH to return at least a 15% 'buy & hold' ROE/yr over the next 5 years. Few recognize that you could very easily (& fairly reliably) double the return by simply trading the volatility; which you could only do if you have a good understanding of the coy & have been actively tracking for at least 2-3 years. Patience doesn't mean blindly 'buy and hold forever'. SD