GalaTime

• Bronte Capital: Goldman’s Orphan Month

… the observant amongst you will notice that these three month periods are not contiguous. Indeed the three months to November 2008 and the three months to March 2009 conveniently forget the month of December 2008. That is right.  Goldman Sachs changed its balance date – and there is a one month period not reported in the usual quarterlies.  An “orphan month”. Now December 2008 was a pretty bad month.  Probably the worst on record.

The net loss applicable to common shareholders for the orphan month was just over a billion dollars.  The four month period was just profitable. Am I surprised that Goldies had an “orphan month” and stuffed the bad news in it?  No.  If you were – then obviously you are new to investment banking.

Does any one still believe in fundamental analysis using publicly available financial statements?

• Times Online: Singapore warns of worst economic plunge amid shrinking GDP

Singapore’s central bank effectively devalued the city state’s currency as the Government warned that the global economic crisis would bring the worst economic plunge on record. Singapore’s unprecedented economic contraction between January and March was described by analysts as “horrendous”. First quarter GDP shrank by 11.5 per cent compared with a year earlier, far outstripping analysts’ predictions.

But worse was the Government’s dramatic revision of GDP forecasts for the full year, said traders in Singapore dealing rooms. A previous prediction of a contraction of between 2 and 5 per cent was revised to between 6 and 9 per cent. It was the third time forecasts have been adjusted in the past five months.

• Bank of England: Why banks failed the stress test

For at-the-money options on UK equities, the insurance premium would have been under-priced by around 45%; for options well out-of-the-money – say, 50% below equity prices at the time – the mis-pricing would have been nearer 90%. This is risk under-pricing on a dramatic scale.

First, the potential losses arising from under-pricing of risk are large. Consider the earlier example of a disaster-myopic writer of deep out-of-the-money put options on UK equities, priced using distributions drawn from the Golden Decade. Let’s say that, in June 2007, a five-year put had been written on the FTSE-100 with a strike price 40% below the prevailing market price. Today, that put would be at-the-money. Hedging that position would crystallise a loss roughly 60 times the income received from having written the option in the first place.

• NSE: Rising Benefits From Cross Margining

The cross margining mechanism implemented by NSE, reduces margins on offsetting positions up to 75% and thereby significantly brings down the costs of trading. Prior to the implementation of a cross margining mechanism all the activities in the equity segment and equity derivatives segment have been treated separately inspite of the common underlying securities in both the segments. With the implementation of cross margining mechanism the market participants are able to efficiently utilize their capital.

Members have benefitted to a significant extent of around Rs.700 crores due to this facility.

Sure this is PR, but having spent some time looking at how SPAN margin works, I agree that cross-margining along with a good understanding of SPAN can lead to very efficient use of capital, especially for autoamted trading systems.

• James Montier, via Value Investor: Clear and present danger: the trinity of risk

Value investing is the only investment approach (of which I am aware) that truly puts risk management at the very heart of the process. Ben Graham was deeply critical of modern finance’s obsession with standard deviation (and I’m sure he would have laughed out loud at VaR). He argued that investors should concentrate on the dangers of ‘permanent loss of capital’.

Graham went on to suggest at least three broad risks that could result in such a loss. We have termed these: valuation risk, business/earnings risk, and balance sheet/financial risk. Valuation risk is perhaps the most obvious of our trinity. Buying an asset that is expensive means that you are reliant upon all the good news being delivered (and then some). There is no margin of safety in such stocks. 

• Forbes: Why Mark-To-Market Accounting Rules Must Die

Mark-to-market accounting existed in the Great Depression, and according to Milton Friedman, who wrote about it just 30 years after the fact, it was responsible for the failure of many banks.

Franklin Roosevelt suspended it in 1938, and between then and 2007 there were no panics or depressions. But when FASB 157, a statement from the Federal Accounting Standards Board, went into effect in 2007, reintroducing mark-to-market accounting, look what happened.

Two things are absolutely essential when fixing financial market problems: time and growth. Time to work things out and growth to make working those things out easier. Mark-to-market accounting takes both of these away.

And our government agrees, atleast as far as forex gains/losses and AS-11 are concerned. Of course, once most companies have forex gains, we’ll reintroduce AS-11.

Oh how I wish I owned some put options on Satyam Computers today. Look at this at-the-money (strike price = 180) January put on Satyam:

Almost a 10-fold return within a day! I don’t even want to look at the out-of-the-money puts.

OK, I could not resist. The January 120 put went from a low of Rs 1 to a high of Rs 99. That is a 99x return in a day. The lot size is 600, so we are talking a profit of almost Rs 60000 per lot. Oh my god!

• CXOAG: Testing A Simple Index Covered Calls Strategy

Does iteratively selling short-term, slightly out-of-the-money covered calls on a broad stock index position reliably outperform buying and holding the index? We can explore the answer to this question by applying assumptions about trading frictions to the CBOE S&P 500 BuyWrite Index (BXM), a benchmark index designed to track the performance of a hypothetical buy-write strategy on the S&P 500 Index.

. . . a rolling covered call strategy on a broad market index suppresses portfolio volatility and may well outperform based on average monthly returns. Access to low trading costs and cash settlement of in-the-money expirations is key to outperformance.

• Wall Street Journal: Is the Medicine Worse Than the Illness?

Trust itself entered a bear market in 2008, complementing and perhaps surpassing the selloffs in stocks, mortgages and commodities. Never to be confused with angels, we humans seem to outdo ourselves when money is on the line. So it is that Bernard Madoff, supposed pillar of the community, stands accused of perpetrating one of the greatest hoaxes since John Law discovered the inflationary possibilities of paper money in the early 18th century.

After Mr. Bernanke gets a good night’s sleep, he should be called to account for once again cutting interest rates at the expense of the long-suffering (and possibly hungry) savers. He should be asked to explain how the central-banking methods of the paper-dollar era represent any improvement, either in practice or theory, over the rigor, elegance, simplicity and predictability of the gold standard. He should be directed to read aloud the text of critique by Elihu Root and explain where, if at all, the old gentleman went wrong. Finally, he should be directed to put himself into the shoes of a foreign holder of U.S. dollars.

• Zeal LLC: Gold Fundamentals 2

Because we are indisputably in the secular-bear stage of our current LVW, the stock markets are likely to grind sideways for another 8 years or so.  The last time a 17-year secular-bear hit the US stock markets, between 1966 and 1982, stock investors were flat on paper but they absorbed tremendous real losses after inflation.  Realize that big 100% cyclical stock bulls are still possible and probable within these secular bears, but when all is said and done stocks will have merely ground sideways for nearly two decades.

. . . the GLD gold ETF in the US (the world’s largest by far) has grown its holdings from nothing to 775t held in trust on behalf of US stock investors in just 4 years!  This single ETF now holds more gold than all but 6 of the world’s biggest central banks!

• DNA: NMDC cuts ore prices by 25% as demand falls

NMDC Ltd, the largest supplier of iron ore, has slashed its prices by 25% across all categories for long-term agreements for the remaining months of the current fiscal.

Iron ore fines, which constitute almost 60% of its supply for long term agreements would come down to Rs 1,500 per tonne. Iron ore lumps, which are of over 65% ferrous grade would be around Rs 2,500 per tonne.

NMDC sells 2.5 million tonnes of ore a month. The total production of the company is around 30 million tonne annually including exports. The company exports just about 10% of its production.

• Business Standard: Sebi restricts early exits from close-ended funds

Sebi, today said investors will not be allowed to exit close-ended mutual fund schemes before they mature and asked fund houses to list them on stock exchanges.

The decision follows the liquidity crisis the industry faced two months ago with investors pulling out from fixed income funds fearing their credit quality. More than Rs 9,000 crore flowed out of debt funds during the period, forcing the Reserve Bank of India to offer money through a special market operation to ease the pressure.

• Economic Times: MF schemes hike exposure to equity derivatives

A bit of hedging and some speculative bets that hold the promise of good returns are prompting mutual fund schemes to increase exposure to equity derivatives. The past 10 months have witnessed several equity funds raising their investments in the derivatives segment to 15-28% of net assets managed. Industry watchers say much of the exposure is largely to derivatives, F&O, on the Nifty.

. . . fund managers are also selling ‘puts’ to make money in recurrently falling markets.

I think they mean selling calls. If so, that should make life interesting if the Nifty shoots up in a short time.

Hindu Business Line: NSE revises lot sizes of derivative contracts

NSE has revised upwards the market lot for 243 stocks in the derivative segment . . . these changes would take effect on the farther month contracts – March 2009 series. 

The upward revision ranges from two to 14 times. Puravankara Projects, which tumbled quite sharply in the recent meltdown, saw its market lot zooming 14 times to 7,000 from current 500.

With markets already witnessing low participations from retail segment, traders are of the opinion that this move could further alienate traders from F&O segment.

Tough call. On one hand, some of the contracts (eg. Unitech) had become ridiculously small. On the other hand, with higher margin requirements imposed by brokers, the larger contract sizes will certainly deter many retail traders.

The NSE and BSE will remain closed today. November Futures & Options expiry has been postponed by a day to the 28th (Friday).