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
on why China's problems are our problem,
on an options strategy that works well in summer and
on a virulent trend in bonds to watch.
Click here for information on
, where you can see all the blogs -- and reader's comments -- in real time.
Rev Shark's Blog: Why We Should Worry About China
Originally published on 5/30/2007 at 8:08 a.m.
"Those that set in motion the forces of evil cannot always control them afterwards."
-- Charles W. Chesnutt
The indices are under some pressure this morning as Chinese stocks dived 6.5% following the increase in a "Trading Tax," which I
Although the tax is quite small and mostly irrelevant in view of the level of gains that have been produced in the China market, it is significant because it indicates the Chinese government's intent to cool off stocks.
No one seriously questions the fact that China stocks -- particularly the Shanghai "A" shares -- are in a speculative bubble. The A shares are traded in a closed market and have performed far better than their counterparts on the Hong Kong exchange. The A shares are up a whopping 74% so far this year following a rise of 126% last year. The average PE is over 40 but the most worrisome aspect of the market is that new accounts are being opened at a staggering rate of 300,000 a day, and stories about average individuals sinking all their assets into the market and giving up jobs to play the market are appearing every day.
The problem for the Chinese government is to cool speculation without killing the market. They don't want stocks to go down; they just don't want them to go up at such a ridiculous pace. Unfortunately, it is nearly impossible to control markets in that manner. Once the beast is released there is no way to stop it. At times things will become excessive and eventually some folks are going to suffer some real pain.
It is obvious Chinese officials are trying to keep things from getting too hot so that when the inevitable correction comes the pain won't be quite as bad. One additional issue that complicates things is the widespread belief that China is anxious to paint a positive, progressive picture as host of the 2008 Summer Olympics. A stock market crash would be a very shameful event and many believe that will keep efforts to cool the stock market somewhat contained.
China is important to our market because it has helped keep worldwide speculation perking along. Who can say that our market is too expensive when you have China trading at much higher multiples?
This morning we have a pretty good-sized hiccup in China and that is causing weakness worldwide. We had a very similar breakdown back in early February that led to a week of weakness but that was soon shrugged off and we moved higher even faster than we had been before the correction.
You can bet there will be plenty of folks looking for another very short-lived correction but let's keep in mind that conditions are changing as we enter summer and the recent climb in the market shows some signs of stress.
We have a sharp dip indicated at the open. Overseas markets are down across the board with most of Europe trading down about 1%. Oil is stable after taking a big hit yesterday and gold is down slightly.
Steven Smith's Blog: Summertime Is Butterfly Season
Originally published on 6/1/2007 at 12:39 p.m.
Early in the week,
I discussed employing strategies that involve selling out-of-the-money puts as a means of profiting the from the current market conditions of a steady bullish trend and low volatility environment.
But understand that this approach of generating income comes with a fair amount of risk. It could be described as a passive/aggressive means of doing so. Even if you use spreads or stops, premium-selling strategies are usually best left to those that have the time and inclination to keep a fairly close eye on the market and monitor their positions. But it is always worth reminding investors that selling a put has the same risk/reward profile of a related covered call.
For those looking for a more hands-off or less stressful way of way to play the possibility that stocks keep trending higher over the next few months might want to consider using butterfly spread strategies. A butterfly spread is a net-debit position, meaning it is a position that is purchased and, unlike a credit position, if the options expire worthless, it will result in a loss. But the loss is limited to the cost, which is usually minimal, meaning the strategy offers a very attractive risk/reward profile.
Another important distinction is this: Credit spreads benefit from flat or moderate price movement in which profits can be realized in a relatively short time period or anytime prior to expiration. An out-of the-money butterfly spread is a more directional and requires definitive price movement and the ability to realize profits increases dramatically as the position approaches its expiration date. For this reason, butterfly spreads are often referred to as vacation positions, in that once established, they require little monitoring or adjusting; one can truly go away and not think about it, and return hoping that the price of the underlying security has landed at the middle strike or body of the butterfly.
Let's look at an example using the
. Assume one thinks this exchange-traded fund, which is currently trading around $154 and tracks the
S&P 500 Index
, can continue its upward trend and gain another 4%-5% in the next three months. One might consider establishing a butterfly spread that would profit if SPY is at $160 at the August expiration. The construction of the position can be done thusly:
Buy one August 156 call for $2.20 per contract.
Sell two August 160 calls for $1.10 per contract.
Buy one August $164 call for 30 cents per contract.
This three-strike position will cost a net debit of 30 cents, or $30, for a 1x2x1 contract position. That cost represents the maximum loss. The maximum profit is $3.70, or $370, if shares of the SPY land right on $160 at the August expiration. This is arrived at by subtracting the spread between the lower strike from the middle strike minus the cost -- in this example, that would be $160 minus $154 minus 0.30 equals $3.70, which has a 1:12 risk/reward. But again, the ability to realize a measurable, let alone the maximum, profit will only become available when the position is less than two weeks from the expiration date.
One way many active option traders or market makers use butterfly spreads is to establish a number of these across various strike prices to build a low-cost inventory of positions that can deliver profits over a large price range. They can use this as a basis for making smaller and shorter-term trades with the knowledge that if the market keeps trending, those out-of the-money butterfly positions are laying in wait to emerge with a beautiful profit.
Tony Crescenzi's Blog: 10-Year Heads for 5%
Originally published on 6/1/2007 at 10:13 a.m.
A cavalcade of economic data will accompany today's employment report, whichpaints a picture of continued economic expansion in the U.S., undeterred bystrains that many expected to result in a much weaker economic climate.
The news is strong enough to further reduce the chances that the
will lower interest rates and instead suggests conditions that will lead torumblings about a possible interest rate hike.
The price deflator that accompanied the payroll report was favorable and will stave off thoughts of a rate hike for now. However, it might not be enough to stop the 10-year T-note from crossing 5.0%, given that the inflation news reflects weak growth for the past year. Plus, the removal of rate-cut expectations eliminates a key justification that has allowed investors to buy Treasuries below the 5.25% fed funds rate: Over the past 18 years, there were only three occasions when the 10-year traded below the funds rate, doing so only when an interest-rate cut was less than sixmonths away.
In short, the bond market is transitioning from a "no recession" variety to a more virulent "the Fed might tighten" variety. I've argued that the "no recession" variety would be treated favorably in risk assets such as equities, and corporate and emerging bond markets. Hence, the 40 basis-point increase in the 10-year's yield since February has been put in the context of the idea that future cash flows would be favorable for stocks, corporate bonds, and the like.
I would bet that the next 20 basis points up in yield would be seen in a much different light because it would happen on the notion that the Fed might raise interest rates. Any rate hike would be many months away, given that it takes at least six months tobuild a case, but this does not mean that the bond market will wait untilthen to price in the possibility.
To have a significant impact on risk markets, the expectation for a rate hike will have to be seen as less than six months away.
The 157,000 payroll gain was largely plain vanilla; there are no specialfactors at play. It is strong enough to absorb the number of newentrants into the labor force, which probably number around 125,000 or lessthese days, owing to demographic factors that are expected to reduce thefigure further in the years to come. This means that the economy doesn't have to create as many jobs as it has in the past in order to hold the jobless rate steady.
The payroll gain was again the result of a vigorous service sector, which added176,000 jobs during the month; the goods-producing sector lost jobs for aseventh straight month. Boosting the service sector was again the health-care sector, which added 36,000 jobs during the month. The leisure andhospitality sector added 46,000 jobs on the heels of a 35,000 gain in restaurantjobs. This sector has added 361,000 jobs over the past year.
Wages are now up 3.8% vs. a year ago, up from 3.7% in April. The figureis running about a half percentage point above normal. This was reinforcedby the data on personal income released alongside the jobs data. Personalincome is now up 5.9% vs. a year ago, about six-tenths of a percentagepoint above normal. The figure on personal income remains the single bestexplanation for how the consumer has held up against the drag from energy costs.
Still puzzling is the figure on construction employment, which was unchanged in May. Only 54,000 jobs have been lost since construction employment peaked last September, much less than most expected. There are several explanations. First, there continues to be an offsetting of job losses in the residential sector by increases in jobs in the nonresidential sector. For example, over the past year, a loss of 109,000 residential specialty contractors has been largely offset by a 91,000 increase in the employment of nonresidential specialty contractors.
A second factor relates to the fact that roughly 1.4 million unauthorized workers work in the construction industry, which employs 7.7 million workers. Layoffs ofunauthorized workers are unrecorded.
A third factor holding construction employment up relates to the government's statistical adjustments to the data. After adding an extra 49,000 workers in April, the government added an extra 40,000 to its tabulation of construction jobs in May to account for an increase in net business formation. The adjustments are meant to reflect the fact that, in recent years, the government undercounted job growth in the construction sector because of the birth of new businesses. It is an adjustment that is obviously not needed now and will likely result in a downward revision toemployment when benchmark data are released in six months.