Hey guys, We’re halfway done with 2011, and so far it’s been an interesting year in the markets. We finished first half with a huge week-long rally that hopefully everyone here could participate in. What has been everyone’s best trade, and how does that fit into everyone’s investment approach? “Best trade” is deliberately an open-ended term – how you define “best trade” is personal, and I’m curious to hear what you would consider a good trade. How you answer this can shed a lot of light upon how you think of investing. Same deal for “worst trade.” I’m hoping this thread will actually turn into a practical discussion about investing and trading, rather than some discussion about purely academic or CFA-related stuff. For me, I have a couple ideas for “best trade” – SNOFF (Sino-Forest) – bought at $2.80 last week, sold at $4.80 today (+71%). This was largely a speculation play after shares traded down nearly 90% after the Muddy Water report. I get that Chinese corporate governance and accounting can be questionable, but the company has been around for 20+ years and even though it’s probably not worth what it was trading at before the report, it’s also probably worth more than 10% of its peak market cap. In any case, the stock has bounced close to 60% since Wellington disclosed a 10% stake in the company on June 30. Anyway, the company has retained PwC to do an accounting investigation in response to the Muddy Water allegations, and that’ll probably take a few months to materialize. I just decided to sell this today because (1) it didn’t really fit into my investing style, and (2) I don’t know how many other near-term catalysts there will be aside from a couple other major buy-side ownership disclosures (potentially). Maybe Wellington knows something I don’t, but I’m happy with the money I’ve made and will leave the speculating to the speculators. AAPL (Apple) – added more to portfolio at $320 earlier this year and also two weeks ago (also still own shares from the $240’s last year). Currently trading at $347. I know this probably doesn’t seem like a “best trade idea” especially since it’s not a position I’ve closed yet, and it’s only up 8% YTD. I gather there are several reasons for this: (1) investors are concerned about the iPhone 5 launch timing and whether sales estimates are too optimistic; (2) underperformance on smartphone sales from RIM and NOK seem to have created an overhang on AAPL’s own smartphone sales; (3) perceived optimism of sell-side analyst expectations and general overvaluation; and (4) no “game-changing” technological introduction on the horizon. However, I think IOS5 and iCloud are underappreciated and will be steady cash cows for AAPL, and the next leg of growth will be in China for 2012, and this is something that seems to be underappreciated by investors with much of the focus so far being on potential launch delays and competitive concerns domestically. Most importantly, I think AAPL at these levels do represent a value play – considering that the company is a leader in product innovation and industry positioning and underlying growth remains strong, I think there’s only upside from here. I scratch my head when I see that it’s trading at a discount to its sector as well as the IT hardware index. About myself: I consider myself to be a value investor with a growth bias, and work for a market-neutral fund that’s about 50% net long.
Worst trade: I don’t think I’ve made any horrible trades this year, but I still look at ways to use the VIX as a hedge since I do have concerns about the true health of the global economy in the next few months. I don’t have any sophisticated way to do this right now other than using VIX ETF’s as an extension of where I believe the markets are headed in the mid-term, and naturally since I am long a handful of VIX ETF’s, I have taken losses on those this year. In any case, I’ve been surprised by the stock market rally in recent weeks and think the market could be overbought when I consider other things like how we’re still in a pretty crappy part of a housing cycle that actually could get worse because of the cheap lending (as if lenders didn’t learn from mistakes in the mid-2000’s), European default risk, sentiment on oil being too bullish given macro risk, weak supply-demand fundamentals on U.S. petroleum, etc. Overall though, I’m not too knowledgeable about using the VIX – can anyone here point me in the direction as to how I should think about playing the VIX, and whether there are other volatility measures that will serve as better hedges? (Also, on this thread, I propose that we also be open to giving and receiving critiques regarding our investment ideas)
I haven’t run the numbers, but my sense is that the VIX isn’t really a great hedging tool. People think it is because “vix goes up in a crisis,” but it also goes up in the recovery from a crisis. In short, volatility can be upside volatility instead of downside volatility. You might not worry about the Vix going up when long exposure goes up, but the problem is that you need to have so much vix exposure in the crisis moments to neutralize your losses that the gradual reduction in volatility during the between-crisis moments eats away at your portfolio returns. I’d use VIX to decide whether options are cheap or expensive, and buy some options when they seem cheap. Sell options when it seems expensive (but cut off your total risk by hedging with deep OTM options). It potentially could be a diversification tool, but not in its raw form, because VIX is most likely a mean reverting process. It doesn’t naturally grow, the way a stock does, or fixed income (in a total return sense).
Best = Years of reward points for ‘free’ flights. Worst = Martingaling bets on 2nd and 3rd 12 sections at roulette table (at least they had ‘free’ drinks) Agreed, long VXX as a hedge is tough unless you can time it perfectly.
^ Unfortunately, “timing it perfectly” is utterly impossible. It’s like trying to time the exact top and bottom and stocks on a daily/weekly basis.
I bought BP at the bottom. I bought a put on BAC that is up 50 percent.
numi Wrote: ------------------------------------------------------- > Worst trade: I don’t think I’ve made any horrible > trades this year, but I still look at ways to use > the VIX as a hedge since I do have concerns about > the true health of the global economy in the next > few months. I don’t have any sophisticated way to > do this right now other than using VIX ETF’s as an > extension of where I believe the markets are > headed in the mid-term, and naturally since I am > long a handful of VIX ETF’s, I have taken losses > on those this year. In any case, I’ve been > surprised by the stock market rally in recent > weeks and think the market could be overbought > when I consider other things like how we’re still > in a pretty crappy part of a housing cycle that > actually could get worse because of the cheap > lending (as if lenders didn’t learn from mistakes > in the mid-2000’s), European default risk, > sentiment on oil being too bullish given macro > risk, weak supply-demand fundamentals on U.S. > petroleum, etc. Overall though, I’m not too > knowledgeable about using the VIX – can anyone > here point me in the direction as to how I should > think about playing the VIX, and whether there are > other volatility measures that will serve as > better hedges? What risk factor(s) are you trying to hedge? Long Beta exposure? Long USD exposure? Note that VIX futures trade on the CBOE, so you can trade there too (or at least get some perspective of expected volatility term-structure).
I’m principally trying to hedge long-beta exposure. What other securities do you like for this purpose?
Best trade was probably buy at 1250 when people thought Tokyo was going to be evacuated… As for the worst trade… I don’t know: too many to count. As for numi’s question: I’m not sure that I understand the scenario. To hedge long beta exposure, why not just sell futures? Or do you mean something else?
numi Wrote: ------------------------------------------------------- > I’m principally trying to hedge long-beta > exposure. What other securities do you like for > this purpose? What’s wrong with ES (or SPY)?
I think Numi wants a cheap alternative to protective put options. By the way, how are we measuring best trade here? Most money made? Best risk adjusted return? Best non-market return? Best decision, whether or not it actually worked? (which is really hard to do with an individual trade, but is ultimately what makes for a good investor).
Sorry justin88, I misspoke. I read your post too quickly. To clarify, what I’m trying to do is to hedge against the possibility that there will be a mid-term correction in equities, which I believe will happen. There are a few things that I consider from time to time when I have an inclination towards making a call on an individual security that I think is overbought – in that case, I’ll execute a covered call or buy a put. However, if I believe that equities are overbought across multiple industries and I’m thinking there’s volatility ahead, I want to own a security that’ll support my belief. That was my reason for looking into VIX futures. However, I recognize I don’t have much sophistication into how to play these or even if they’re the best for that purpose. bchadwick and LPoulin133 suggest there are better options. Thoughts?
So are you betting that the broad market will go down or that volatility will increase? You’re still kind of beating around the bush. For the first scenario, sell futures or short SPY. For the second scenario, buy some index straddles or something. You can look on Bloomberg to see which contracts have the most vega.
bchadwick Wrote: ------------------------------------------------------- > I think Numi wants a cheap alternative to > protective put options. The instruments we’re discussing are largely fungible/convertible/risk-reversible, so there’s no “cheap alternative”. Something’s only “cheap” when it covers a limited amount of risk. The best one can do is precisely identify one’s risk and choose an appropriate hedge instrument.
I’m not sure there are better options in terms of securities. One possibility is to think about overweighting defensive sectors or sectors that you think will outperform the market as a whole if there is a correction. Usually that is utilities, consumer staples, and other dividend stocks, and underweight those that require growth, such as financials, technology, and consumer discretionary. But that will only make you lose less than the market as a whole, not protect you from a true correction. Over the long term, correctly making these adjustments will give you a better performance, but I doubt it keep your blood pressure low during a correction. The VIX is about at its lowest level since the 2008 crisis, so maybe it’s just worth forking out the premium for a put option on ES or SPY. You can pay for it with a covered call if you want to reduce the cost. You can also put stop orders at critical values, but if the market bounces, you could get caught not catching the rebound. That’s one reason why options are worth money and that using stops as “a cheap option” can backfire. You can also make a shopping list of stocks that you would be willing to buy during a correction. Perhaps they’re not worth owning now, but you would consider them on a pullback. In that case, sell some puts on them at a price or valuation that you would consider reasonable. You’ll get some cash now, and if you end up having to buy them, you’ve already done your due diligence. So it’s more about asking yourself “how will I handle myself if I wake up tomorrow and the market is down 5%” Will I be all cash, or will I be bargain hunting? Obviously, that does depend on having a view on why the market could be down that much, but there’s nothing that prevents you from developing scenarios and strategies to match each of them.
ohai Wrote: ------------------------------------------------------- > So are you betting that the broad market will go > down or that volatility will increase? You’re > still kind of beating around the bush. For the > first scenario, sell futures or short SPY. For the > second scenario, buy some index straddles or > something. You can look on Bloomberg to see which > contracts have the most vega. I like ohai’s analysis here. There is a distinction between hedging a broad market collapse and speculating on an increase in volatility. You might have an outlook that says to do both. But why are you hedging beta exposure? Do you have taxable events you are trying to avoid, and so you want a hedging instrument? Why not just reduce your beta exposure if you think it’s too much. Hold more cash, or shift into low-beta stocks?
bchadwick Wrote: ------------------------------------------------------- > By the way, how are we measuring best trade here? > > Most money made? > > Best risk adjusted return? > > Best non-market return? > > Best decision, whether or not it actually worked? > (which is really hard to do with an individual > trade, but is ultimately what makes for a good > investor). This is totally your call. My original question was deliberately flexible so as to gain some insight into how people here think about investing, how each person defines investment success. There are many ways to succeed and also many ways to fail in the markets, and it all depends on each person’s objectives and investment criteria. So, as you guys answer the question regarding best and worst trades, please try to state your investment preferences and style.
I don’t really think there’s anything wrong with buying a put of a certain term that matches your view to protect against possible downside for a cost you’re comfortable with. If you do think the market’s overbought, sell a call against it to finance the put. The simplest, most cost effective method, is probaby to just figure out a dollar exposure you’re ok with and hedge according to that using SPY/ES, inverse ETF, etc. …if you just want a position that will benefit from increased vega, buy a straddle.
“and work for a market-neutral fund that’s about 50% net long.” please explain how that is a market-neutral fund…
mcap11 Wrote: ------------------------------------------------------- > “and work for a market-neutral fund that’s about > 50% net long.” > > please explain how that is a market-neutral > fund… pretty sure he meant long-short, not MN.