Cointegration

I recently listened in on a Mathworks seminar about cointegration and tests used to determine if cointegration exists. I thought the best part was providing a sample trading strategy based on divergence and eventual convergence of cointegrated stocks - and how they used various tests to create indicators for the day-trading time horizon. I've always been a more long-term oriented investor - but I do see the need shift to shorter-term strategies, especially in this headline-moving market.

I will definitely delve into this area some more and share some of the trading ideas I come across along the way.

I Finally Agree With David Bove For Once

Long shorted names?

YTD, most-shorted names up 5.8% vs Russell 3k's 4%.

Decent strategy might be to long the most shorted stocks and hedge with some OTM VIX calls or OTM S&P puts.

Here's a list of the most shorted stocks thanks to CapIQ

The 5 questions of 2012

Happy 2012. 5 key questions to ponder as this year progresses:

1. Will US growth be greater or less than consensus?
2. How much will the Eurocrisis subtract from US growth?
3. Will US housing bottom in 2012?
4. Will there be Fed easing? Where?
5. Will inflation be higher or lower than Fed target?

Happy trading.

Portfolio deconstruction

Here's a quick look at my portfolio as of now:

~30% in cash - looking for short term plays and liquidity when the volatile markets swing in my favor

~ 30% short Europe - through ETF's / put options

~5% short the Euro/USD - Euro has had it's run up, expecting low 1.3x by the end of the year on nothing good coming out of the Eurozone.

~10% physical silver - PM's are a great store of value.

~ 25% pot pourri of hand-picked stocks that are underweight utilities and overweight non-cyclical goods & services. Net short on financials.

Plan on playing more broadly as this market is definitely headline driven. Watch out for news out of Europe, and for God's sake stop buying on the rumor and selling on the news. All positive news out of Europe coming from FT.com or The Guardian is utter nonsense, and nothing is credible unless an official is willing to put his name behind it. The half-life of rumors has died down considerably, but that hasn't helped market volatility.

If you want you can try and be nimble and take a quick profit off rumors & their subsequent refutation, but that depends on your risk appetite. Mines is currently smaller than usual, and I am looking for more convergence trades and obvious mispricings (VIX @ 25?!).

Happy trading.

The Big Three

Forget Greece for a second. Forget Italy. Forget the individual countries, and let's look at Europe more systemically. There are three issues that seem to be good flag posts for the ongoing crisis, and there can't seem to be a solution that solves all three. Addressing two of the three issues seems to starve the third of much needed attention.

Those three things are:

1) Bank solvency

2) Sovereign stress

3) Bank funding

It's interesting how when addressing bank funding and bank solvency (naked CDS/stock shorting ban), the sovereign risk seems to have blown out.

Over the next three years, ~$1.7 trillion worth of debt needs to be rolled out (either paid or kicked down the road with the issuance of new debt). An EFSF levered 4x-5x will not be able to cover such an amount, not to mention the bank recaps and continual buying of securities. A number closer to $2 trillion would be needed... but seeing as how bond auctions can barely get covered in Europe as it is now, all with extremely high yields, it does not seem like this problem is shrinking nor solved.

A Deal!

Yay! The Eurozone is saved!

Private investors have agreed to a 50% haircut on their Greek debt... but is it really a 50% haircut? As ZH reports:

• Greece has €350 billion in total debt including about €70 billion in Troika "post-petition" loans; these are untouched.
• Of the €280 billion, roughly €75 billion is held by the ECB: this, like the Troika loans, will be untouched.
• This leaves just ~€200 billion in actual debt to undergo a haircut.
• Apply a 50% haircut to this debt (ignoring the fact that of this about €35 billion is held by Greek pension funds, and once the realization that Greek pensions have been cut in half dawns upon the population, the result will be the biggest riots ever seen in Athens yet).
• Total debt to be cut: just about €100 billion.
• Hence, of the total €350 billion, just €100 billion is eliminated, most of it used to backstop and service Greek pension and retirement obligations
• €250, or the residual, of €350, the original, means 72%, or a 28% haircut.
  
• Greek GDP was €230 billion on December 31, 2010 and declining fast.
  
• And that is how a 50% haircut is "cut" almost in half

The real question is... how is this going to affect the banks that are holding on to massive amounts of Greek debt? Many of them are currently under review for credit downgrades... this will only be fuel to the contagion fire.