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Feb 19, 2016

Where the Risk Lies in Oil & Bonds | Truth or Skepticism

By:Josh Fabian

This election year is proving unique. Candidates that historically would not be able to get enough supporters to fill a phone booth are blazing ahead of the pack. At least one of these candidates is proposing a transactional tax. Those who support a transactional tax fail to realize how such a tax ultimately supports the “too big to fail” system whose foundation rests on passive investing.

Enacting a transactional tax would increase trading costs, which could ultimately discourage active investing and drive even more money into passive investment firms. Travel down that road just a little and it is not difficult to understand Tom’s argument that a transactional tax will ultimately cause liquidity to dry up in the world’s most important market. Think markets are volatile now? Imagine them with 50% less liquidity.

The economies of the world are all continuing to struggle. Some central banks have begun policies of negative interest rates. In theory, charging interest on excess reserves should result in more money being put to use in an economy. Tom is skeptical of such a policy and questions not only the influence central banks truly have, but whether or not they are being “played” by financial institutions.

Intervention on the part of central banks, be it in the form of quantitative easing or negative interest rates, has resulted in what Dylan called “asset inflation.” Be it bonds or equities, the end result of Fed intervention resulted in overvalued prices. Returns on index funds during this period of intervention have given financial firms ammunition when arguing investors should passively invest their money.

Tom’s question is whether or not central bank policy has been the result of manipulation by the large firms who have benefitted most from intervention. The positive results from passive investing have made asset gathering that much easier. Continuing monetary policies that lead to asset inflation and proposing legislation to further discourage active investing is a path that keeps individual investors financially ignorant while supporting the very institutions whose actions helped create the financial mess we are still trying to clean.

As for markets themselves, Tom was nostalgic for option expiration of yesteryear. From his special shoes to the excitement expiration Friday once generated, today’s option expiration cycle is like having seen The Rolling Stones back in the 70s: young, hungry and full of energy (as well as other substances) then awaking from a coma and seeing them today...old.

The advent of weekly options has resulted in the excitement of that third Friday of every month being special. Once upon a time, expiration Friday could be counted on for a flurry of activity. Now those Fridays are nothing more than another day. Still, with options expiring today, many investors are facing the question of closing out losing positions or rolling them out to March.

At tastytrade, we’ve done our homework and extensively researched how to handle losing positions. Traditional finance suggests investors take their losses and move along. This becomes more arsenal for firms discouraging active investing.

Dylan, speaking on behalf of “his friend” who is short Tesla puts, asked Tom for his top picks right now and where the greatest risks remain. It’s a given Tom is short S&P and bond futures. In addition to that though, Tom is bullish on being short premium. Puts, calls or both, it doesn’t matter, with volatility as high as it is and a triple witching hour looming in March, Tom is selling premium while he can. March has a history of volatility collapsing anywhere from 4-7%, which means there may be a shrinking period of time for collecting premium.

As for risks, oil and bonds top Tom’s list. With oil currently trading near $31-$32, Tom sees greater risk in a move to the upside. Prices in oil are down from over $100/bl just 18 months ago. With oil being closer to zero than 100, and knowing oil will never reach zero, in Tom’s opinion, the risk is a run up in oil. Bonds have just the opposite risk. Interest rates on 30-year bonds are hovering around 2%. How much higher can bonds truly go? Probably not much. However, a move down could be a long move.

Josh Fabian has been trading futures and derivatives for more than 25 years.

For more on this topic see:

Truth Or Skepticism: Where the Risk Lies in Oil & Bonds: February 19, 2016

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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