RealMoney's Best of Blogs

As always, RealMoney's bloggers were all over the market action this week, and we'd like to share the best of their recent commentary with readers of TheStreet.com. These posts best capture the intent of these blogs, which is to provide intelligent discussion on the issues each writer sees as most pressing that day.

Let's take a look at Rev Shark on trading vs. gambling, Steve Smith on new pricing for options spreads and Tony Crescenzi on the whether the ECB and Fed really know what's going on.

Click here for information on RealMoney.com, where you can see all the blogs -- and readers' comments -- in real time.

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Rev Shark's Blog: This Market Makes Trading a Gamble
Originally published on 8/9/2007 at 8:33 a.m. EDT

He was a degenerate gambler. That is, a man who gambled simply to gamble and must lose. As a hero who goes to war must die. Show me a gambler and I'll show you a loser, show me a hero and I'll show you a corpse.
-- Mario Puzo

The market action yesterday was the most unusual that I have experienced since I started trading 15 years ago. There were some huge moves in random small-cap stocks that seemed to have no relationship to fundamentals, technicals or anything else that I could think of.

At the same time, a contingent of small-caps that have positive news and numbers acted very poor. In addition, some of the big-caps you would think would lead a surging market, such as Apple (AAPL Quote) and Goldman Sachs (GS Quote), fared poorly.

To further complicate matters, a late-afternoon swoon and a quick bounce was the ideal recipe to shake out traders who were playing the momentum game.

Market players are scratching their heads and trying to figure out what exactly is behind this unusual surge in volatility. Some are speculating that the recent demise of the uptick rule, which made shorting more difficult, may be playing a part in the wild swings. Many small-caps were crushed far more than the broad market in recent weeks. A big short fund could easily induce some panic in these names without expending huge amounts of capital to push them down.

The spike yesterday looked like the pressure was suddenly relieved amid a surge in short covering and realization that there really was nothing fundamentally wrong with many of these stocks.

There is also talk about large macro funds and program trading pushing the market around as billions are reallocated to deal with a market that is obviously undergoing some changes in character. There is also talk about moves by the little-known but extremely powerful sovereign wealth funds that control trillions in funds.

I'm not sure what it is that is affecting this market, but there is no question that it is very powerful and giving us some very random moves. The problem for market players is that this action is tantamount to a slot machine. There is no way to easily game this. As we see this morning, the tremendous strength of one day gives way to an ugly open the next

Unfortunately, many market players believe the stock market is just a form of gambling. They place their bets and hope for a payoff. On the other hand, the professional speculator realizes that there is substantial risk in the market, but he or she takes action to control it. The pro doesn't just throw money into a volatile situation and hope things work. He or she controls his risk, uses stops, money management and other tools to ensure that losses are contained.

In a market that is acting like this one, it is extremely difficult to be a thoughtful, risk-adverse speculator. The random action increases the risks that stops will be triggered and losses locked in.

There are some who think they can figure out what is going to happen in this market, but putting money on the line at this point comes with a very high risk that you will have things go against you to a painful degree first. Being right is cold comfort if you can't withstand the swings in the interim.

There is no denying that this market is not offering much clarity for the market players who want to minimize risk. Anything you do right now is an outright gamble, and the smart speculator avoids playing that game.

We have an ugly open on the way as the subprime issues hit European banks. Yesterday it was the bears who were badly positioned. Today, it looks like the bulls who are finding themselves suddenly without support.

Be careful out there. If you are going to play this market, think of it like a slot machine and don't put too much capital on the line.

No positions.

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Steven Smith's Blog: Spread for the Bread
Originally published on 8/6/2007 at 1:03 p.m. EDT

Market volatility remains near high five-year highs, and that is good for both exchanges and brokerage firms, as it tends to spur an increase in trading volume. It can be good for traders', especially those that use options as large price swings offer more trading opportunities. But one of the downsides of trading more is the accompanying increase in commissions.

This becomes doubly true with options due to the fact that as volatility rises, it makes increasing sense to use spread or multi-strike strategies, that is, the simultaneous purchase and sale of similar options. The reason is that by using spreads, one decreases the vega risk, or the impact that a change in implied volatility will have on the value of the options.

So, unlike a year ago when option prices were sitting at decade lows, the risk of using single-strike strategies, such as simply buying puts or calls out right, was minimal; after all, how badly can you get hurt falling out of the first fall?

But now that trading has occurred about 10 flights higher, using strategies that both buy and sell options on the same underlying security brings the risk back to a more manageable level. You may get bruised by a fall in IV, or if you are short options a further increase, but you'll survive as the combination of being both long and short options will hopefully offset any changes in IV would have on the value of the position.

And now there is the good news for traders that many online brokers are starting to treat spreads and multi-strike trades as a single transaction. On Monday OptionsXpress (OXPS Quote) announced it will now consider option spreads a single trade to calculate commission if all "legs" are executed simultaneously. Previously, each leg was considered a separate trade. This is especially attractive for retail traders that typically don't trade more than five or 10 contracts at time, which made commissions on spread trades prohibitively expensive.

Under the new pricing, commissions for multi-leg trades with up to four legs will be $1.25 per contract, with a $12.95 minimum for customers who trade more than 35 times per quarter. The commission rate for customers who trade less frequently will be $1.50 per contract, with a $14.95 minimum.

"As retail investors become better educated, they are using more advanced option strategies designed to maximize the return and limit the risk in their portfolios," said David Kalt, Chief Executive Officer of OptionsXpress. "As a result, spread trades such as straddles, butterflies and condors have grown quickly in popularity, and we are responding by matching commissions to the way our customers trade."

An example of the savings can be seen on a five-contract, two-leg spread trade. The new commission is $12.95 for active traders, compared to $25.90 under the old pricing. For a five-contract condor (a four-leg strategy), the new commission is $25 compared to $51.80 previously. That's nearly a 75% cost reduction.

The guys from Investools(SWIM Quote) are quick to point out that the ThinkorSwim platform has always treated spreads as single transactions. Founder Tom Sosnoff notes that ThinkorSwim was launched during the bubble days when volatility was running sky high and its clients were sophisticated enough to know that using spreads was simply a must for controlling risk.

He says their current rates for spreads are still below almost every discount broker out there. He also adds that "an increase in volatility is a wonderful thing for traders and brokers alike, that is, until it gets too high. Then, it's not so good." But Sosnoff feels we are long way from being too high.

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Tony Crescenzi's Blog: The ECB's extraordinary Action
Originally published on 8/9/2007 at 10:51 p.m. EDT

In Europe, the interbank rate jumped sharply overnight, trading at 5.86%, the highest since 2001. This prompted the European Central Bank to lend $130 billion to European banks, which were seeking liquidity they found difficult to obtain in a market frozen by the BNP news.

In the U.S., the interbank rate, the fed funds rate, has also moved higher, although not dramatically. It's now 5.50%, a quarter point above the Fed's target. Although not high, the funds rate has traded this high fewer than 10 times over the past year.

The $130 billion injection by the ECB is extraordinary. On Sept. 12, 2001, in response to the extraordinary circumstances, the total amount of deposits at the 12 Federal Reserve Banks, which captures the scale of the Fed's liquidity injections, was $102 billion, 5 times normal.

According to notes in my recently published book, the 1,200 page revision to Stigum's Money Market, the average daily size of the Fed's daily open market operations was $6.4 billion in 2005 and the size of its 14-day repos, which are announced most Thursdays, was $8.7 billion. Today the Fed conducted a $12 billion 14-day operation, responding to the jump in the fed funds rate. It can thus be said that liquidity squeeze in Europe is impacting the U.S.

As the ECB said, it will fill 100% of all requests for in order to assure orderly conditions in the money market. Hence, there will be plenty of liquidity to handle the problem no matter the scale because the ECB can print as much money as is necessary.

What stands out most from this situation is its proximity to the Federal Reserve's meeting on Tuesday. If the Fed had even the slightest inkling that a problem of this scale might occur, its statement would have had a full tilt toward neutral rather than the partial tilt it gave. Today's events show that either the Fed committed a large policy error on Tuesday, or that both the Fed and the ECB are themselves more in the dark on the problems that lie underneath the surface than are investors in the financial markets.

While the Fed and the ECB may not have the providence to see all problems that exist, it should at the very least have a greater sense about conditions in the markets it controls -- the money market and the credit markets more generally -- and of conditions in the banking system.

As an aside, with Basel II set to be implemented at the end of the year, policymakers must ask whether the new capital standards will be enough to safeguard the world's banking system against situations such as this one, where asset values are more difficult than normal to fairly value.