TINA Is Not A Bubble

There.  Is.  No.  Alternative.  We’ve heard it from all of the talking heads.  There is no alternative to the stock market, so you might as well buy and enjoy the ride.  And the fact that there is no alternative is inflating a bubble.  And when that bubble pops, it’s going to get bad.  Really bad.

Well, I hate to break it to the guys on the sideline waiting for the bubble to burst.  This is not a bubble.  To be a bubble in the truest sense of the word, there has to be euphoric-type buying.  To be a bit over-extended to the upside, we have to have capitulation buying.  And that’s what we have now – a high priced market that should pull back when the last bear in the room throws in the towel.  But this market will not collapse.  In 2000, all you had to do was buy every .com IPO and you were destined to turn your thousands into millions.  In 2007, just buy houses.  You could always sell them a year later for more, renovate and flip them, or find any other number of ways to make money.  And you could do it all for no money down.  You just had to make sure you bought houses.  And in both the .com bubble and the housing bubble, everyone knew that you were going to make money fast and everyone with a little spare money did just that.  And everyone that didn’t have spare money found a way to borrow money so they could get in on the game.  It ended badly.

But in today’s day and age, we’re simply searching for yield.  We’re searching because we need to generate 6-8% per year in returns to finance our retirements.  But with interest rates under 1%, we’re certainly not going to get it from bonds.  We’re going to get it from stocks with high dividend yields.  And when that dividend yield isn’t high enough, we’ll get it from financing the debt of small cap companies that can pay us an annual coupon of 6%.  And then we’ll buy all those small cap stocks because the debt instruments don’t yield enough return.  And then, since they’re not paying dividends, we’ll sell out-of-the-money calls to create a new yield instrument whereby we can collect 10% per year of the stock’s value in premium if we don’t rally and we make 15-20% if the stock rallies through our strikes and takes us out of our position.  And then, when the implied volatility is too low for that, we’ll continue to find another way to generate yield.  Maybe that will be the bubble.  But for now, the bubble isn’t there – we’re still just finding the little bit of yield out there.  And we’re frowning while we do it, because this is not a euphoric easy-money game.

And that’s how we get to where we are today with a P/E ratio that makes us cringe every time we buy the index.  This is not a bubble.  This is not a scenario where every day-trader with a subscription to seeking alpha and a cable modem is gleefully throwing money into the market simply knowing they’ll be rich.  Rather, this is a market where pension funds and money managers are doing everything they can to find the best deals out there so they can squeeze out a little alpha and make up for the low interest rate and low volatility world we are in.  And the good ones will manage that money appropriately if and when the facts change, but until Central Banks start raising rates in unison, the stock markets will continue to be a low volatility source of returns that help make the 6% needed to finance retirement accounts.  Just like CDs, Savings Bonds, and Government Bonds used to be.

You may be asking yourself why I am spitting out a big macro speech on how the world isn’t going to crumble when you came here to read about trading theory.  Of course, my expertise is option theory and portfolio construction, not macro theory.  But, if you want to structure option trades playing for a tail event or betting against them, you have to know your tail event and have conviction when the market starts to look scary to everyone else.  An interest rate hike of 25 bps is not going to cause a tail event.  Global Central Banks will be there with more QE to ensure that, and getting the fed funds rate to 50 or 75 or 100 bps will still not generate enough yield to pull money out of the stock market.  Retirement accounts are still under water if they get into 1% interest bearing instruments.  So what’s the tail risk right now?  Perhaps for the world of US equity indexes, there simply isn’t one.  Maybe someone will decide it’s time for WWIII.  That would certainly count as a way to start a tail risk, but you can’t bet on war.  Individual companies could go bankrupt, but that won’t likely destabilize global markets.  We’ve seen a number of oil companies go bankrupt, and we survived.  That’s not enough of a problem to kill TINA – we can simply make her sway.

Managed Money is record short the VIX.  And why not?  When I look at the markets right now, the best trade appears to be short puts on the equity markets at the right time.  You can’t sell them when the market is skyrocketing since there’s no real yield, but in those few brief moments where the market shows signs of a 1-1.5% collapse (I wish this was sarcasm, but instead, it’s realism), and the VIX spikes to an incredibly high value like 20% (again, realism), you have to recognize what you’re getting – yield.  The investment world is hunting for yield, and they are selling the VIX to find it.  And until the yield from other investments returns to a high enough level to get yield somewhere else, you’ll get it from the VIX.  And if the yield returns to the outright stocks, we’ll buy those instead.  So why wouldn’t we buy the dips in stocks and sell the rallies in the VIX?

Structuring the trade is the fun part – you can sell puts naked at a high IV level.  If skew stays low, you can sell put spreads.  Maybe the term structure gets out of whack and you can play calendars.  Or, you can buy call 1x2s in a deferred month to play for a rally with an IV hit and more limited upside.  And then there’s deciding how and when to take the profits when the VIX gets back down to a point where it doesn’t yield enough to be short vol.  But that’s something to evaluate on a case-by-case basis.  In the meantime, just know that you have to be ready to get short premium when the VIX rallies.

So next time the S&P 500 collapses 1.5% and the VIX spikes above 20%, get your finger on the trigger to sell options. TINA.



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