Follow Up on the Swaption Fly

The 1:2:1 butterfly on 3-month, 6-m and 12-m options on 1-year swaps did retrace from its low of -27 bpVol on Nov 20 to about -11 bpVol yesterday.

Follow-Up on the VIX

The VIX did continue to drop -- until Dubai scared the markets on Thanksgiving.

Follow-Up on Masco vs Mohawk

The P&L Wednesday would have been 0.263 * (42.40-41.36) + (14.39-14.09) = $0.573 per short share, or equivalently per 0.264 long share. The P&L today is 0.263 * (41.80-41.36) + (14.39-13.70) = $0.80 for the same pair trade.

Consummer (Food) Staples

In this post, we focus on consumer food staple companies: Campbell Soup (CPB, in pink below), HJ Heinz (HNZ, in orange), ConAgra (CAG, green), Sara Lee (SLE, blue) and General Mills (GIS, yellow). We can see that their CDS's tend to be very close, except for GIS in the first half of the year, and for HNZ, which tightened significantly lately. (The graph is normalized in that all time series start at 100.)



Their equities show similar relationships: they're highly correlated, and the stocks of HNZ, GIS and CPG have had the same return since the beginning of the period under consideration. (The graph is normalized again.)



We can notice, among other things, that the divergence of the CDS on Campbell Soup and HJ Heinz is surprising given that their equities have moved in lockstep. If we "zoom" on the companies, we see that indeed the costs of their CDS's are tightly correlated, but that today's market is an outlier:



This would suggest the following trade: go long (sell protection on) Campbell Soup while shorting (buying protection on) Heinz. Of note: CPB has been a favorite short of hedge funds lately, which may have pushed the cost of its protection higher than justified by fundamentals.

Gold Holding by the Gold iShares ETF

The amount of gold held by the gold iShares (shown in amber) has recently increased, but still has caught up with the increase in the value of the ETF shares (in white). The graph is normalized so that both time series start at 100. The bottom graph shows the ratio of the two series; its peak illustrates the fact that the gold reserves of the ETF are low by historical standards -- but of course, the value of that reserve has increased, which is not reflected here.



Another way to look at the same data, since the beginning of the index on Bloomberg. Gold holdings, in weight, increased by almost 20% while shares jumped more than 34%. Gold holdings are in Troy ounces.

Pair Trade: Masco vs Mohawk Industries

Masco and Mohawk Industries have the same credit worthiness, as illustrated by their CDS graphs:



Their stocks are highly correlated, too: the R-squared of the regression is 92%. However, Masco's stock is far (several standard deviations) from the value implied by linear regression, which would be around $11.



In this pair trade, since the slope of the regression line is 0.263, we would be long 0.263 shares of Mohawk for each share of Masco shorted.

The Same Swaption Butterfly

This is the same swaption butterfly than the one posted Nov 10, which retraced nicely toward its historical average and gave a nice profit. We have a new entry point today.

Cano Petroleum

Resaca Exploitation announced their acquisition of Cano Petroleum on Sept 30. Interestingly, Cano's stock skyrocketed 3 weeks before the deal was announced publicly, on unusually large volumes... Perhaps the SEC will want to have a look?

Bid-Ask on the CDX IG Index

The bid-ask spread on the CDX IG index (shown in amber below) dropped to its lowest level since 07. Interestingly, the VIX (shown in white) seems to be lagging, as usual, so we can expect VIX to catch up and drop. The bottom graph shows the VIX/bid-ask ratio, which just jumped but presumably will revert to its historical mean.

Follow-Up on the Swaption Butterfly

I hope you took your profit on Friday: the 1:2:1 fly on 3mx1y /
6mx1y / 1yx1y swaptions retraced, as expected.

Worst Performers among CDX Sectors

What a House Bill can change... Among massive tightening (even some homebuilders tightened, e.g. Toll Brothers), pharma and healthcare were the two sectors that widened most.

Follow-Up on the Lockheed/General Dynamic Trade

As of 12:20pm today, Lockheed was at $74.95 and GD at $67.05. The P&L on the pair trade since we initiated it on October 28 is:

• Gain on LMT = 74.95 - 68.32 = $6.63/share

• Loss on the short GD position = 67.05 - 64.30 = $2.75/share

The slope of th regression was 0.869, implying being long 0.869 LMT share for each GD share being shorted. Profit is thus 0.869*6.63 - 2.75 = $3.01 per GD share shorted.

1:2:1 Butterly on 1-Year Options with 3m/6m/1y Expiries

The 1:2:1 butterly on swaptions on the 1-year rate at 3m, 6m and 1y expiries is at its second most extreme level in 10 years -- the first one occured in September this year, and was follow by significant retracement. Expect the retracement from the current outlier to be similar, thus offering a significant potential for profit.

Is the U.S. Fed Fund Rate Too High or Too Low?

Is the U.S. Fed fund rate too high or too low? The Taylor Rule is the standard rule of thumb. With the original values, given the economy, the Fed Fund should be negative 2.25%! The screen shot below reflects the original values given by Taylor to the different coefficients. We can still his estimate (shown in blue) is pretty close to the historical values (in white).

According to Goldman Sachs (cited here), this implies that “Since the Fed can’t lower rates to less than zero, the Taylor rule means the central bank has to pump money into the economy through other methods, such as purchases of Treasuries, mortgage securities and agency bonds.”

Using better coefficient values (i.e., so that back-testing shows lower error; alpha and beta = 0.30), the Fed Fun rate would not increase before September 2010. Interestingly, that’s about what Eurodollar futures also imply -- see this older dataforthoughts post.

The Yield Curve as a Leading Indicator of Recessions

The Fed of NY just published its latest stats on the probability of a recession in the next 12 months according to the slope of the yield curve. According to that model, this probability is now almost 0:

Peabody and Commercial Metals Co.

The equity of Peabody has jumped relative to that of Commercial Metals. The graph below shows both plotted in the same graph (top pane), and their ratio (bottom pane):



This phenomenon est recent: the graph below shows that the pair has been diverging from its historical relationship. The blue points correspond to that last 30 days or so, and the yellow points to the previous 5 months.



The cost of protection on Peabody, however, is higher than that on CMC:



This may indicate that Peabody's equity is rich relative to that of CMC. (We can't however exclude the possibility of a change of correlation regime; we would need to look deeper at fundamentals and at recent news to exclude the option.)

Alternatively, these observations may tell us that market players expect a takeover of BTU, which would explain the sudden premium on its equity and its relatively higher CDS spread.

What Banks Charge Consummers -- Continued

From a Bloomberg news release today:
"The rate on a five-year auto loan is 4.49 percentage points higher than on a similar-maturity certificate of deposit that a bank can sell to raise cash, according to Bankrate.com data. That’s up from an average of 2.05 percentage points in the five years through 2007. Spreads between so-called jumbo 30-year mortgages and 10-year Treasuries average 2.71 percentage points, up from 1.58 percentage points in the same period."

What's the Future of Rating Agencies?

It feels like the proverbial rats are leaving the rating agencies’ ship:
Oct 31 -- Warren Buffett's Berkshire Hathaway has reportedly lowered its stake in debt ratings agency Moody's by 2.9% this week.
Nov. 2 -- Fimalac completed the sale of a 20 percent stake in Fitch Ratings for 300 million euros.