(Editor’s Note: Mr. Vialoux is scheduled to appear on BNN Television on Monday at 4:50 PM EST)
Pre-opening Comments for Friday December 7th
U.S. equity index futures are higher this morning. S&P 500 futures are up 8 points in pre-opening trade.
Index futures moved higher following release of a better than expected November U.S. employment report. Consensus for November Non-farm payrolls was 80,000 versus 138,000 in October. Actual was 146,000. Consensus for Private Non-farm payrolls was 120,000. Actual was 147,000. Consensus for the November unemployment rate was an increase to 8.0% from 7.9% in October. Actual was a decline to 7.7%. Consensus for November Hourly Earnings was unchanged from October. Actual was a gain of 0.2%. Hurricane Sandy did not have a significant impact on the report.
Canada also had an encouraging November employment report. Consensus was an increase in employment of 10,000 from October. Actual was an increase to 58,300. Consensus for the November unemployment rate was unchanged from October at 7.4%. Actual was a decline to 7.2%.
CIBC adjusted its ratings on Canadian bank stocks. Toronto Dominion was downgraded from Outperform to Sector Perform. Royal Bank was upgraded from Sector Perform to Outperform.
Sun Trust initiated coverage on the U.S. financial services sector. Buy ratings were allocated to JP Morgan, PNC Financial and Citigroup. Neutral ratings were allocated to Goldman Sachs, Wells Fargo, US Bancorp, Huntington Bancshares and Bank of America.
McDonalds added $1.00 to $89.09 after Janney Capital upgraded the stock from Neutral to Buy.
Topeka launched coverage on the U.S. Homebuilder sector. Pulte Homes and Ryland Group were rated Buy. Toll Brothers, KB Homes, Lennar and DR Horton were rated Hold.
Airline stocks are “flying higher” on weakness in crude oil and refined product (i.e. jet fuel) prices.
China “A” shares and their related funds continue to show strong technical patterns.
Strength in precious metals yesterday was recorded despite an exceptional gain by the U.S. Dollar Index, an encouraging technical sign.
An Update on Sector Seasonal Trades
The following sector seasonal trades remain in gear. All trades:
· Currently are profitable
· Have at least a short term uptrend
· Remain above their 20 day moving average
· Show short term momentum indicators in an uptrend (although many are overbought)
· Indicate positive strength relative to the market (S&P 500 Index: down 0.09% during the past week)
Gain during the past week: 1.32%
Gain during the past week: 1.83%
Gain during the past week: 1.53%
Gain during the past week: 1.11%
Gain during the past week: 0.11%
Lost 0.53% during the past week
Lost 0.34% during the past week.
Lost 0.72% during the past week.
Lost 3.98% during the past week
Lost 0.71% during the past week.
Lost 0.82% during the past week.
Gained 1.09% during the past week.
Lost 1.53% during the past week.
The following sectors have shown technical deterioration during the past week despite their favourable seasonality. Both have broken below their 20 day moving average and are no longer outperforming the S&P 500 Index. They are giving technical early warning signs.
Loss during the past week: 2.51%
Lost 2.70% last week
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Copper Futures (HG) Seasonal Chart
Eric Wheatley’s Listed Options Column
I’ve been dealing with options only tangentially in this space for the past couple commentaries. This week, I’ll go in the opposite direction and dive into a rather hard-core concept which stumped me many years ago.
A good friend of mine from when I was at the Montréal Exchange named George threw a theoretical options question at me one day while we were outside smoking. George has a big math brain, though he had never traded options. At the time, I only had a cheap Bachelor’s of Finance from a school of little repute (and whatever repute it does have ain’t good), but I knew how options worked under the hood and could eyeball things in a manner which could only be learned in the pits. Our conversations were pretty fun and we could teach each other all sorts of interesting and mutually-fulfilling stuff.
He asked me: “if implied volatility rises to infinity, what’ll happen to a call’s delta? What about a put’s?”
Of course, I now have to explain a few things. This is the graph of a call’s delta:
The intuitive definition of delta is “the probability of an option’s being in-the-money at its expiration”. A call with a strike price of $30 will be in-the-money if the stock’s price is above $30 at expiration. Therefore, in the graph, if the stock’s price is at $50, the 30-strike call will have a pretty darned good chance of being in-the-money and will therefore have a delta of close to 100%. Conversely, a call with a strike price of $70 has very little chance of being in-the-money at expiration, so its delta will be close to 0%.
The rub here is that if the stock’s price is extremely volatile, there is less certainty as to the aforementioned probabilities. Sure, the stock is at $50, but a 70-strike call is a lottery ticket – with an extremely volatile stock, that lottery ticket may pay off. The graph therefore shows that delta is less extreme when volatility rises; that is, the curve will be flatter because out-of-the-money options become more likely to get into the money and in-the-money options are more likely to fall out-of-the-money.
SO, to get back to George’s question: what if volatility flies to infinity? The intuitive answer would be that the curve would be perfectly flat. All calls’ and all puts’ deltas would be 50%/-50%. This is the intuitive thought which comes to the mind of a non-big-brained options trader. George smiled and, darnit, told me: “nope.
“The math says that if volatility rises to infinity, all calls’ deltas will be 100% and all puts’ deltas will be 0%”. He explained the theoretical underpinnings and I was fascinated, but I couldn’t wrap my head around how this quantum physics-like stuff could be explained intuitively.
As is usually the case, I tried to understand the puzzle for a little bit, then I ctrl-alt-del-terminated the process in favour of using my frontal lobe for more pressing matters, such as Zooey Deschanel (or whomever her 2001 equivalent was. Probably Amanda Peet). The fun thing was, my subconscious kept working at it and later that evening, it hit on something.
If volatility is infinite, that means that the stock could, at any finite moment, be at any price from zero to infinity. An option must have at least one finite strike price. Even if the strike price is seven kajillion hundred million and thirty-eight, if volatility is infinite, the probability of the stock’s price being higher than seven kajillion hundred million and thirty-eight at expiration is infinitely close to 100%. Therefore, a call with a strike price of seven kajillion hundred million and thirty-eight WILL be in-the-money at expiration, so its delta is 100%. Conversely, a put with a strike price of seven kajillion hundred million and thirty-eight will NOT be in-the-money at expiration, so its delta is 0%.
Now, just as there is a tipping point between quantum and classical mechanics in physics which isn’t yet known, there has to be a threshold dividing “normal” volatility – where calls and puts tend towards 50% when it rises – and this “quantum” infinite volatility. I’ve no clue of how the math would work, so if a reader is much smarter than I*, please write.
(*Just the idea of “infinite” volatility doesn’t make much sense to me, considering that volatility is usually defined as the standard deviation of a sample. In order to calculate the standard deviation, you need the mean. How do you get the mean of infinity? This is why I’d make a pretty grumpy theoretician. If you can expose my ignorance, go right ahead).
An article from the Twitter feed from this week (‘twas a happily busy week and I saw few interesting articles):
· According to Goldman Sachs, the U.S. will be going through above-trend growth. Good news? Is it possible?
In this week’s French-language blog: I had spent a weekend with our good friends in Québec City debating, among other things, capitalism and globalisation. This was my considered response after a bit of cogitation.
Éric Wheatley, MBA, CIM
Associate Portfolio Manager, J.C. Hood Investment Counsel Inc.
Blogue en français : gbsfinancier.blogspot.ca
Little known fact about John Charles Hood #53
Disclaimer: Comments and opinions offered in this report at www.timingthemarket.ca are for information only. They should not be considered as advice to purchase or to sell mentioned securities. Data offered in this report is believed to be accurate, but is not guaranteed.
Don and Jon Vialoux are research analysts for Horizons Investment Management Inc. All of the views expressed herein are the personal views of the authors and are not necessarily the views of Horizons Investment Management Inc., although any of the recommendations found herein may be reflected in positions or transactions in the various client portfolios managed by Horizons Investment Management Inc
Horizons Seasonal Rotation ETF HAC December 6th 2012