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"Markets have false sense of security"

The Wall Street Journal might be channeling their inner-Devesh. They note that there's been a flood of money into options-backed funds and ETFs, but the news is not all good. Jon Sindreu (3/8/2024) writes:
If you bought so-called structured products recently, you have plenty of company. But is precisely their popularity that could make them - and perhaps the entire stock market - riskier than they seem ... The bargain often appeals to less-sophisticated investors who otherwise might not dabble in complex derivatives. For banks they bring in fat fees.
There follows a discussion of one class of derivatives, called "autocallables." At base, banks are the counterparties in the autocallable trade, so they have an incentive to hope for market stability which, in part, is caused by their own need to busy "insurance" against their exposure to these options. Sindreu summarizes:
So autocallables look attractive because the stock market is calm, but the market is calm because people are buying so many autocallables. The feedback loop is reminiscent of the one created by funds that directly wagered against volatility back in 2017 and 2018. When a bout of selling broke the cycle, banks stopped hedging, volatility exploded and the market tanked.
His conclusion: you shouldn't trust the Vix as a gauge of potential trouble. Quoting Jeffrey Yu of BNY Mellon, "Low volatility begets low volatility. Until something goes wrong."

Interesting article, though much of the mechanics of the trade are a bit over my head. In any case, it's offered for what it's worth.
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Comments

  • Counterparties by their actions increase volatility both when coming off the bottom and the top.
  • Jon Sindreu mentions JEPI...$32B AUM and very quickly.

    I do recall a recent conversation with Kevin Simpson of DIVO fame, indicating that high volatility enhances the distribution potential of running a covered call ETF...FWIW.
  • AI, semiconductors and Fed rate-cut mania. Is Bitcoin still hot? Yep. The markets can only go up.
  • Yep- sure thing, for as long as I can remember. So do Boeing 737s. What could possibly go wrong?
  • The options market is big, opaque, listed, Over-the-counter (private transactions), complex and because of the option expirations, constantly changing. It's hard to get a sense of just the trees, let alone the forest. Huge doses of humility are called for when trying to analyze and predict the world of options.
  • Devo said:

    The options market is big, opaque, listed, Over-the-counter (private transactions), complex and because of the option expirations, constantly changing. It's hard to get a sense of just the trees, let alone the forest. Huge doses of humility are called for when trying to analyze and predict the world of options.

    I appreciate the education you gave me on options a little while back.

    I would be interested in your opinion of DIVO.
  • Hmmm... Devo on DIVO... Has a nice ring to it!
  • Hmmm... Devo on DIVO... Has a nice ring to it!

    I resisted the temptation.

    But now,

    "Crack that whip."
  • Will try Sir.
  • Well, there are @Devo, DIVO, Davo, Davos.

    DIVO is a call-writing funds. It's lags the industry giant JEPI and is more expensive too. In the up markets like this, it may be covering its calls, or its stocks are being called away. But that is the deal - you give up some upside for options income. Here are the charts for JEPI, DIVO, IVV/SP500.

    https://stockcharts.com/h-perf/ui?s=JEPI&compare=DIVO,IVV&id=p47538115979
  • edited March 10
    Lipper categorizes DIVO as an equity-income fund. In that category it is an MFO "Great Owl." At the present time it is writing calls against four stocks in its portfolio rather than the entire S&P 500.

    For me, JEPI does not have enough of a track record. And I am not sold on the idea of writing calls against entire indexes.

    If I set MFO premium to a five-year window, DIVO's APR out performs all of the other ETF's in the Options Arbitrage category, and with respectable Martin and Sortino scores. Over its seven year history it outperforms its competitors, and has the best Martin and Sortino scores. If one only looks back a year, then DIVO and JEPI are getting smoked by the majority of etf's in the category.

    For my purposes, DIVO was competing with AMFFX rather than JEPI. DIVO is cheaper than AMFFX. DIVO versus AMFFX.

    Yet another dinky linky.
  • edited March 10
    @wabac,

    I was not familiar with AMFFX and so looked it up. Still can not figure out why you compared it with DIVO. Please say more / share more.

    P.S.: For me, derivative income equity funds are a different animal than historical traditional equity income funds. But there may be similarities between them that may be compelling for others and i would like to understand.
  • @BaluBalu, conservative portfolio, low standard deviation, low Beta, low R-squared; and not dissuaded by M* calling it a Derivative Income fund.

    Here is what the prospectus has to say about that part of their strategy:
    CWP seeks to lower risk and enhance total return by tactically selling short-term call option contracts on some, or all, of the Equity Securities in the Portfolio. . . . Unlike a systematic covered call program, CWP is not obligated to continuously cover each individual equity position. When one of the underlying stocks demonstrates strength or an increase in implied volatility, CWP identifies that opportunity and sells call option contracts tactically, rather than keeping all positions covered and limiting potential upside
    That doesn't sound crazy to me. I can't speak to why Lipper considers it an equity-income fund.
  • Thanks @wabac. I experimented with derivative income (did not learn the term from M*) products. There can be a place in a portfolio for these but I decided to keep them out to keep the place open. Between JEPI and Divo, I liked Divo for the part you quoted.
  • I learned today that JR from M* has written a few articles on the subject. There is a new article from him on the topic and may be someone can link that article here.
  • BaluBalu said:

    I learned today that JR from M* has written a few articles on the subject. There is a new article from him on the topic and may be someone can link that article here.

    Here's the punchline:
    I would not buy these funds. When possible, choose simplicity! But I will not lecture those who do. They are unlikely to develop cavities.
    I still hold DIVO in the taxable in case we need the income down the line.
  • I exited JEPI late last year because of what YBB's chart illustrates. However add QQQ and JEPQ to Yogi's chart and tell me what you see.
  • edited July 2
    Thanks, @WABAC, for adding the link to the article.

    For those that are color challenged (blind) -

    https://www.morningstar.com/columns/rekenthaler-report/boomer-candy-sweet-treats-or-investment-toothache

    I have not read JR's previous articles on the topic.

    I agree with striving for simplicity. DIVO is simple enough for you and I - I think we talked about it before.

    I have heard negative media comments about writing covered calls on bonds (or fixed income ETFs). In the fixed income realm, IMHO, that is probably simple when one considers the level of complexity that exists in the bond land. Perhaps, @Devo can chime in.

    I get that "simple" has an individual definition. I think if an investment can not be owned at least up to 5% of PV, it is probably not simple for that person.

    Disclosure: The only boomer candy I own are the Hedge Equity strategies.

  • As LTC Hal Moore said at the Battle of Ia Drang Valley, "Nothing's wrong ... except there's nothing's wrong."

    I agree the markets are treading water and churning - there is a false sense of security forming, but at least it's not overwhelmed with bullish exuberance. Maybe that's b/c of the geopolitical and electoral climate around the world this year?
  • Today's Ed Yardeni column is titled : "Soft Patch Getting Softer Possibly Raising Odds of Fed Rate Cut in September & Stock Market Meltup"

    Bad news is good news. until...bad news is bad news?

  • Devo said:

    Today's Ed Yardeni column is titled : "Soft Patch Getting Softer Possibly Raising Odds of Fed Rate Cut in September & Stock Market Meltup"

    Bad news is good news. until...bad news is bad news?

    [S]aid Mr. Dooley, “no matther whether th’ constitution follows th’ flag or not, th’ supreme coort follows th’ iliction returns.
    Perhaps the Fed anticipates them?
  • rforno said:


    As LTC Hal Moore said at the Battle of Ia Drang Valley, "Nothing's wrong ... except there's nothing's wrong."

    I agree the markets are treading water and churning - there is a false sense of security forming, but at least it's not overwhelmed with bullish exuberance. Maybe that's b/c of the geopolitical and electoral climate around the world this year?

    All you have to see is a nice uptrend of the SP500 chart since 11/2023(link).
  • edited July 3
    FD1000 said:

    rforno said:


    As LTC Hal Moore said at the Battle of Ia Drang Valley, "Nothing's wrong ... except there's nothing's wrong."

    I agree the markets are treading water and churning - there is a false sense of security forming, but at least it's not overwhelmed with bullish exuberance. Maybe that's b/c of the geopolitical and electoral climate around the world this year?

    All you have to see is a nice uptrend of the SP500 chart since 11/2023(link).
    To clarify: My comments reflect my accounts (income-oriented, value equities), not the broad market.

    That said, take out the Mag-7 and that chart will look a lot different, I bet.
  • edited July 4
    Sure, take out the engine of the world, and things will look different.
    Value has been lagging for about 15 years now.
    But one day.... :-)
  • FD1000 said:

    Sure, take out the engine of the world, and things will look different.
    Value has been lagging for about 15 years now.
    But one day.... :-)

    I got one word fer yooz: PLASTICS. ...Ooops, wrong movie.

    I got one word fer yooz--- in line with @rforno's remark: BREADTH.
    A healthier Market would show more breadth of profit, in addition to the crazy-nutso, irrational shot upward in the MAG-7.

    But you most often seem to want to talk past what others have to say; so, carry on.
  • Despite the notion of a "false sense of security" in the US markets, the S&P is UP 8.7% and NASDAQ is UP 14.1% since the date of the OP. Here's hoping no forum participants acted inappropriately on that notion!
  • It all depends on your time horizon and how much you need the money.

    Big Tech was flat for a decade after the Dot.com boom but that ignore the 45% or more drop initially. Small caps EM etc did much better

    Earnings estimates for SP500 are dropping explaining the lack of breath.

    diversification doesn't help until it is critical
  • edited July 7
    To the Editor:

    I know we are at a market top when my 17-year-old son is begging me to allow him to trade these options with his savings from birthdays and graduation (‘Traders Are Flocking to Risky Zero-Dated Options. You Can Go Completely Broke.’ )


    - Letters to the Editor - Barron’s July 8, 2024
  • If someone really knew what was going to happen next do you think they'd tell anyone else? Hint: no.
  • edited July 9
    It's pretty sad and going on for years. Be scared of US LC, especially the MAG 5-6-7
    But let me sell you NOW Value, SC, EM and CEFs.
    Wait, last Dec the "experts" told us that the Fed is going to cut 5-6-7 times, buy Treasuries. VGIT is finally at 0.2% YTD.
    It's amazing how these "experts" get paid and have a job.

    Sure, one day it will happen.

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