Everyone has been quietly terrified that the Greek contagion would spread from one PIIGS (Portugal, Italy, Ireland, Greece and Spain) to another. Now it’s clear the real “swine flu” is just beginning.

Last week, S&P announced a cut to Portugal’s sovereign credit rating from A+ to A-, down two notches.

But the cut of Portugal wasn’t enough. That slipped across my wire about 11:00 a.m. (EST) on Tuesday. At 11:30 a.m., European Central Bank (ECB) President J.C. Trichet, announced that a default of Greece was “out of the question,” even though he refused to comment on the current negotiations.

It seems he may have just been whistling in the graveyard. Just 15 minutes later, everyone’s greatest fears came true: S&P announced that they had cut Greece’s bond rating to “junk” (BBB+).

And following that, Spain saw its credit rating slashed, too.

What on Earth will happen next?

Bloomberg reports that Greece’s two-year bond soared to 17% after its rate cut announcement. This is why Germany was calling for more austerity cuts to the Greek budget before they signed on to any bailout agreement.

But it looks like that may all be history thanks to a $145 billion bailout agreement made between European governments and the International Monetary Fund to bail Greece out of its mess. The bailout may have quelled some concerns about the fate of the collective Eurozone economy, but its effects have been muted by the prospects of what’s potentially still to come across the pond.

I have made the case here before and will again re-state it: There is not enough money to bail out all the struggling nations of Europe. Take a gander at these GDP figures (in 2009 U.S. dollars) and its ratio of public debt-to-GDP:

Now compare the same table with external debt (in 2009 U.S. dollars):

I’ll leave you to your own devices to calculate what the percentage to GDP the external debt is. And just for the record, the difference between the two kinds of debt is that public debt is essentially what the government owes. External debt is basically all debt combined. That’s the easiest way to remember it.

And now here we are with three of the infamous PIIGS getting a poorly timed rate cut. How can a government with such a debt load ever hope to crawl out from underneath it? It would be hard even if the country could borrow money at a 0% interest… let alone at 17%!

The handwriting is on the wall.

I was pretty sure that when the news broke last week about the downgrades, that we would close the NY session with the euro below 1.32. Sure enough, we did.

It is hard to say what exactly will happen going forward. Government structures stay in place for a long time, even after the heart of the beast is already eaten out with cancer. This is why the United States is still on its feet. We become accustomed to certain fixtures remaining in place.

Other countries have defaulted on their loans and are still here. In the highly developed West, that is almost a given. In other places, such as a number we could name on the African continent, not only can whole governments change hands, but countries will change names and governing structures altogether.

So while the Union may not dissolve, and may not change its name, its governmental structures have already been altered. Had the Maastricht treaty that created the Union been held in strictest of understandings and interpretations, no country would ever come close to a default. But then again, the countries with fringe economies had their financial standing and accountability issues papered over in the first place.

Otherwise, they would likely never have been let into the clique.

As you might expect, I’ll be watching how the situation unfolds very carefully… I’ll keep you updated.

Sincerely,
Bill Jenkins
The Penny Sleuth

May 4, 2010

Update: The PIIGS Get Slaughtered was originally featured in the Penny Sleuth.

Here’s a quick look at what’s going on in the world from a forex standpoint…

Australia Points to Recovery

As I predicted to my Master FX Options Trader readers earlier this week, the Reserve Bank of Australia (RBA) did indeed raise interest rates again, up a quarter point to a major market-leading figure of 4.25%.

If you’re keeping count, that’s the fifth increase in six meetings.

With housing prices climbing, unemployment believed to have peaked and housing credit expanding at a firm pace, the Bank stated it wants to move toward more “average rates.” In other words, the RBA believes recovery is under way.

The response to the rate hike was predictable, but muted. The currency climbed 100 pips in seven hours, creating a double top around .9250 (with the previous peak occurring on March 7) before pulling back to .9230. Is this the pinnacle before the foundation crumbles, or is it the start of another bull leg?

Don’t Trust U.S. Equity Rebounds

Economic news out of the United States is stellar: Jobs are being created. Pending home sales are up on a massive scale. The Institute for Supply Management’s service index jumped more than double what was expected. Fed-heads are “reviewing” the discount rate. (While not the same as the Fed Funds rate, an increase in the discount rate would still be a very bullish measure for the buck.)

But, as always, all that good news raises more questions than it answers.

For instance, the month of March saw weekly new unemployment claims above 1.5 million. So the creation of 160,000 jobs does very little to offset that. Pending home sales are an interesting forward-looking figure — but show me the completed sales and the comparative prices from where we were at the beginning of this whole debacle.

I can’t say that there is no good news coming out of the United States. But if anyone thinks that this is a recovery based on real private sector jobs because of real private sector hiring, and that real private sector spending is creating real private sector demand… think again.

EU: Greece Just Won’t Go Away…

A bloodbath.

That’s how one of my friends described the activity in Greek bonds to start the week. When I last checked, the spread on the Greek 3–6-month bonds was almost 250 basis points. What is that and what does it mean?

When you compare rates between two different maturities on bonds, it gives you an idea of what investors are charging governments for different amounts of holding time. As a rule, the longer you hold, the more risk you are taking, and the more you want to be compensated. But a 3–6-month period is barely any comparison at all. There would generally be very small differences in the rate. The difference is called the spread. For comparison purposes, the spread on the U.S. 3-6-month bonds is only 9 basis points. Investors are giving very much credence to the success of Greece even just six months out!

This has been the main news out of the European Union and will continue to be. It does have an interest rate announcement later in the week on Thursday. The European Central Bank is expected to stand pat. What else could it do? Maybe throw the PIIGS a bone and cut rates… but I wouldn’t count on it.

The UK Swells for a Pullback

The pound had seen a nice little retracement from the third week of March. But an intermediate-term double top precipitated a small pullback. GDP had been revised upward, and a jump in manufacturing provided some real release for pent-up bulls in the sterling. But slumping mortgage approvals continued to press down to a 15-month low. Like other Western economies, houses and their accompanying equity provided spending money in the United Kingdom during the last big bubble. The hope is to return housing-related spending to its previous levels. Such bad news on the mortgage credit front is a frontal attack on the Bank of England’s (BOE) efforts to keep the fledgling recovery going.

To that end, the BoE has not shut down it asset purchase program, although it has placed it on hold for the time being. The purchasing manager index (PMI) for the service sector was released today, showing a much larger drop than was expected. Thursday will also bring its interest rate announcement. Like the ECB, the bank is expected to stand pat. Should this resistance hold at 1.5330, we may be preparing for the next leg down.

Is the Yen Oversold Right Now?

In a significant correction, the yen has moved 9 cents from the end of November. This drop took it out of the trading range it had been following and may offer us a good opportunity. While the Bank of Japan decided to keep interest rates steady, there has been good news coming from the economy. Japan’s leading indicator exceeded expectations by more than a point. This on the heels of the best retail sales growth in four years, in addition to increasing factory orders.

In short, there is no good reason for the yen to continue to weaken, and we may see a nice move back up. Also, the 200-day moving average continues to fall, even while the 50-day moving average is bumping up against it. From a technical viewpoint, this could produce a bullish relationship with the dollar and see a run at the recent high around 117.

Until next time,
Bill Jenkins
Penny Sleuth

April 8, 2010

Foreign Exchange Markets: Around the World in 80 Pips was originally featured in the Penny Sleuth.

We are sitting in the middle of a week packed with economic data, and it will be capped off on Friday by the granddaddy of them all, the Non Farm Payrolls. As I’ve noted in the past, it seems nearly inconceivable that the dollar should be embarking on any kind of serious run, but I am also well aware of the irrationality of the market.

Good U.S. GDP numbers, profitability numbers and uncertainty about Greece going forward all fueled the dollar fire last week. On Monday we saw U.S. incomes drop but spending go up — which I believe got us into this mess in the first place.

Of course, consumers’ habits die hard. If they feel there is a reasonable security about the future, they will start spending. And people seem to think the future is secure, as least according to the latest U.S. consumer confidence numbers, which came in considerably higher than forecast.

That meant the dollar, which had been mildly bid beforehand, suddenly became very popular.

The pound dropped, the euro dropped, the yen dropped, the Aussie dropped.

But the enthusiasm might be short-lived. We had the ADP figure hit Wall Street yesterday, which came in at a real disappointing loss of 23,000 jobs, after expecting a gain of 40,000. This has produced something of a sell-off in the dollar, but we’ll see if it follows through.

Chicago PMI also failed to meet expectations, but factory orders were slightly above expectations. All of this leads up to the big number on Friday. The real question becomes, is the dollar being viewed as something more than a safe haven? Is it morphing into an asset? Are traders going to start viewing the dollar as a viable holding tool?

It is hard to imagine holding dollars when the interest offset is so great against counterparts like the kiwi and the Aussie. But under the “dogs” theory of the markets, last year’s whipping boys become this year’s stellar winners. And this week’s figures have a lot hanging in the balance.

But we’re more concerned with what’s going on with Greece this week…

Why Greece Faces More Challenges in 2010

Despite all the enthusiasm over the Greek bailout announcement, I don’t think its problems are over. The country has reportedly covered its April and May debt rollover, but it is hard to say it is out of the woods.

At this point it is very much like American consumers who continually rolled over their debt into their house payment by refinancing. It worked spectacularly in the short run, but there was a limit to how long they could continue putting off repaying the loan.

The only long-term solution, of course, is to eliminate the debt entirely. But the cold, hard truth is that the country is far more likely to spend the refinance money getting straightened out, only to return to their old habits. Plus we haven’t even come close to the end of the line in terms of the other countries that are in real trouble there.

Will the IMF arrange a deal for all of them? Will that actually help? The bailouts are based on the fact that we are headed into a recovery. The odds are just as high, or maybe higher, that we aren’t. No recovery, no payback. No payback, and the euro continues its decline.

But the real meat of the accord seems to be missing. Bailout money isn’t just doled out willy-nilly (who in their right mind would do a silly thing like that?), but there were no parameters set for what would be considered reasonable circumstances for a request. Also, all parties must be in agreement on the loans. On top of that there was no “cost” assigned to the loans. One would think that the cost would not be cheap, which would encourage carelessness, but one would also think that too high of a cost would endanger whatever recovery may be taking place.

So all is not yet clear for the eurozone, and we may see more downside ahead.

Until next time,
Bill Jenkins
Penny Sleuth

April 1, 2010

Why Refinancing Debt Isn’t a Long-Term Solution for Greece was originally featured in the Penny Sleuth.

The U.S. dollar has been on a run since December, when the dollar index hit a low near .74. From there it has climbed to almost .81. It has suffered a couple of dips… but each time it has rebounded. Its trajectory is still upward, and we look for it to exceed the recent high around .8130.

How high can it go? At the same time, we also need to ask, how far can the euro fall?

That’s because, as you probably know, the dollar index represents the value of a dollar compared to a basket of select currencies. But the currencies that make up the basket aren’t weighted evenly. And perhaps not surprisingly, the euro gets the most weight — accounting for nearly 58% of the index’s value.

So the dollar may be weak, but as long as Greece (and now Portugal) stays in the headlines and the euro continues to drop, the U.S. dollar index will continue to rise. Thus a weakening euro may be starting, or at least encouraging, a dollar bull run.

That being said, markets can turn on a dime, and nascent bull runs can quickly flip-flop into bear selling opportunities.

The U.S. housing data was released on Tuesday. Existing home sales crept up, and housing prices did not fall as far as expected. As a result, the USD sold off slightly but not significantly.

Durable goods orders came in less than expected. Last month the figure was revised upward from 2.5% to 3.9%. This month was forecast for a paltry 0.6%, but only reached 0.5%.

That’s about it for the direct news on the U.S. dollar, though. For the indirect news, we need to check in on the other side of the Atlantic.

Taking Stock of the Greek Situation

There is a European Union summit today and Friday. Many believe that the “Shootout in the EU Corral” will happen then. Up until now, the standoff has existed between Greece’s George Papandreou and Germany’s Angela Merkel. Each one is waiting for the other to draw.

Greece demanded last week that the EU put together some sort of bailout package with low-interest loans that it could access and be “saved.” It gave the EU one week to come up with it. Coincidentally, that falls on the same day as the EU summit this week. Greece will be waiting for an answer. If none is forthcoming, it has threatened to go to the IMF for a loan.

It’s a “threat” because an emergency call to the IMF would show that world’s second-largest economy can’t get its own house in order. It would call into question the very core of EU stability, its inter-country cooperation.

Unfortunately for Greece, and the EU, Germany has indicated that it would support an IMF intervention. In fact, on Monday Merkel warned that no one should look for a rescue plan coming out of Brussels.

If Germany is truly intent on calling Greece’s bluff, there won’t be a Greek bailout, because any plan — including an EU emergency fund for countries — can’t succeed without Germany going along.

So what’s next? Greece must sell 10 billion euros worth of bonds to roll over debt that is coming due in April and May. Some are forecasting a failed auction. I’m not inclined to agree. I think Greece can move its bonds. The question is, at what price? Already Greek bonds offer nearly twice the yield of the Germans — the benchmark for Europe.

But Papandreou has announced that Greece must be able to borrow at a rate less than what is currently available… and that the rates must be “sustainable.”

Amid the back and forth between Germany and Greece, another one of the European PIIGS (Portugal, Italy, Ireland, Greece and Spain) has bad news of its own. Fitch Ratings has downgraded Portugal’s sovereign bonds, questioning the country’s debt status. The markets are reacting violently to the news and it’s sure to be a topic at the EU summit.

So the cauldron is bubbling — we shall see what sort of concoction will emerge. But I think one thing is for certain: Should a second wave of risk aversion come crashing down on the forex shores because of Greece’s or Portugal’s problems, it will not likely be papered over with calming assurances like it was before.

I’ll be watching closely for the rest of the week.

Until next time,
Bill Jenkins
Penny Sleuth

March 25, 2010

An Update on the Greek Debt Fiasco was originally featured in the Penny Sleuth.

When a person (who qualifies for unemployment) loses his (or her, but it’s a pain to keep using two pronouns) job, his application for benefits is recorded under the weekly initial jobless claims.

If he is still out of work after a week (and who isn’t these days?), then when he collects benefits on week two, he is placed in the continuing claims category. In most recent years, the continuing claims benefit continued for 26 weeks.

I guess the supposition is that if you haven’t found a new job in half a year, you weren’t really looking anyway. The government isn’t going to put up with you being so “lazy”… so you would collect no more money.

But ever since the world collapse that has brought so many government benefits out of the woodwork (and just as many people to collect them), pressure has been applied to extend these benefits under emergency measures to continue supporting those who remain out of work longer term. Handily enough, they are called extended benefits and emergency benefits.

Now here’s the kicker: Even though we have been witnessing steady declines in the headline numbers of the new and continuing claims for unemployed, the emergency benefits portion of unemployment has been rising FASTER than the other two headline numbers have been falling.

Last June, the number of continuing claims topped out at 6.9 million. Since then, they have retraced by 30% to just above 4.5 million. Under the extended benefits plan, we have a somewhat better showing, where the numbers have fallen from 520,000 to 260,000. So that’s basically cut in half. Unfortunately, as mentioned above, the number of people who are now living on EMERGENCY benefits has ballooned. From last June, when there were 2.6 million on the emergency rolls, the number has MORE THAN DOUBLED to 5.6 million. It’s also worthy of note that this is the highest number to date.

In other words, this figure is actively growing and, even worse, showing no signs of abating.

When the numbers are released, the drop in unemployment is simply an accounting quirk, whereby aid recipients are moved from the headline numbers to the emergency category. And you can tell from the figures I’ve given you that the fall in the continuing claims category is actually exceeded by the number of enrollees on the emergency rolls.

The grand total of non-working citizens has jumped 30% in the last nine months, from 8 million to 10.2 million. When we look at the Non-Farm Payroll numbers next month, they will purport to tell us how many jobs have been created. Last month it was a huge positive surprise. But it is awfully hard to believe we are creating jobs while the unemployment figures are swelling beyond belief.

I think it must be kind of like all the money given to the banks to lend to us “little people,” which never seems to reach us. Here are jobs, created for the “everyman,” but meanwhile, he sits unemployed each week, bringing him closer to the end of his benefits — and the end of his rope.

What does this mean as we look forward?

Simply this… if we do not have another leg of recessionary activity ahead, I do not know how it will be averted. Common economic theory maintains that monetary stimulation is the only means whereby an economy can be revived.

The United States has massively stimulated its economy. So has Europe. So has China.

Government spending is a real and present danger. And while many of the governments have halted various stimulus programs and are already hinting at removing excess liquidity, perhaps later this year or early in the next, at this point in time I cannot see how. Be wary about the economic numbers you’re fed.

Until next time,
Bill Jenkins

February 10, 2010

What Unemployment Numbers Really Mean for Your Investments was originally featured in the Penny Sleuth.

From time to time a substantial story rolls along that, while outside of my normal purview of our direct options, may still have an indirect impact on currency plays — and the Master FX Options Trader portfolio.

Such is the case with the United Arab Emirates, Abu Dhabi, Dubai, and its state-owned conglomerate, Dubai World.

If you heard all the Dubai news over the Thanksgiving weekend and saw the palpable fear on some commentators’ faces, but wondered what it all meant, I’m here today to set things straight.

Let’s begin with just a summary of the region and how it works.

The UAE, United Arab Emirates, is a confederation of seven states (called emirates). The two most well known are Abu Dhabi and Dubai.

The capital of the seven emirates is Abu Dhabi; it is the wealthiest and second-largest city in the group. It also lays claim to the sixth-largest oil reserve in the world. Just to prohibit some confusion, Abu Dhabi is the name of both the capital city and the state it is in, something like New York, New York.

In some respects, Abu Dhabi is like an older, wiser, more fiscally conservative brother to Dubai, which has been rather profligate in its assumption of debt and flamboyant in its projection the state’s image. Being a sort of Las Vegas and Disneyland of the region, it has built a gorgeous skyline, and as its oil revenues have dwindled, they have turned their attention to the money to be made in tourism. But attracting tourists to the desert is a difficult proposition. It takes glitz. It takes glamour. And apparently it takes around $60 billion in borrowed money.

The borrowing, however, was not done by the state of Dubai directly, and is not owed directly by them to any creditors. Instead, Dubai has a state-owned but “independent” company called Dubai World. My guess is that the more problems that stem out of the company, the more “independent” it will become. At any rate, this company has been the driving engine and catalyst for much of the growth seen in the region.

I do not know how much they have spent already. I don’t know how much they have borrowed and repaid up to this point. But that, as they say, is, water under the bridge. What matters is that they have requested a payment hiatus on $60 billion in loans.

The emirate of Dubai has said it is washing its hands of the whole thing. They are not offering a bailout, and they are not guaranteeing the company. This, of course, troubled investors and depositors in Dubai’s banks. Fearing a run on the “company store,” the central bank of the UAE stepped up to the plate and guaranteed all deposits in regional banks. In other words, no reason for the public to be afraid (and frankly, the markets liked that, too).

But what they didn’t say may be just as important — because the speech from the Dubai “Fed” did not offer help to the troubled Dubai World conglomerate. Essentially, since it guaranteed the public’s deposits but didn’t fork over public money to bail the troubled company out, they took the taxpayer right off the hook. If this is truly how it unfolds, then hooray for Abu Dhabi. The U.S. Fed could take some lessons. But the play is not quite over yet. If the UAE is not going to be on the hook for Dubai World’s excesses, who is? Who actually lent all this money out in the first place?

Actually, it looks as though the United Kingdom could be the hardest hit. Half of that debt is owed to banks based there. Some $13 billion of that money is on loan from the Royal Bank of Scotland and Standard Chartered; another $17 billion is from HSBC, whose stock fell from $62 down to $58 on the news.

Since the United Kingdom is still struggling to get any kind of recovery started, the news weighed heavily on its currency — at least initially. More bad debt on the books is not exactly what it needed at this point. Since the United Kingdom has already been issued a warning by Fitch about its sovereign debt rating, it certainly does not want an increase in borrowing costs for their gilts. This only adds to that burden.

But the world of finance has some pretty big bullies in it. I would think it highly likely that Abu Dhabi would be the subject of great external pressure if the situation remains wobbly. And this pressure could lead them to the conclusion that Dubai World is “to big to fail.”

That would relieve the pressure from the Eurozone (which has exposure by way of Germany) and U.K. banks. Beyond all doubt the West has financed itself up to its eyeballs, and one on this side of the world is willing to tack on a little more. RGE’s Nouriel Roubini is already predicting that the cost of U.S. bailout debt will rise from 40% to 80% of GDP. Not much room to borrow there.

And certainly Europe won’t be volunteering much help, because it’s having troubles of its own. It was recently announced that the cost of financing Greece’s debt has grown equal to that of Turkey’s debt… at one time considered a far more risky proposition. Should those individual countries continue to add to the red side of Europe’s ledger, some of the other larger states will need to jump in and bail them out. In the past, I’ve talked about the PIGS of the Eurozone: Portugal, Ireland, Greece and Spain. Add them to the increasing troubles in Lavia, Lithuania, Estonia, Belgium and Hungary, where foreign debt now exceeds 100% of GDP, and the “camel’s back” grows increasingly weaker.

But I digress. Back to Dubai… and Dubai World. CMA Datavision, a credit market tracking company, puts the chance at a full default of Dubai World at just under 36%. And while that would be bad for banks, it could have real effects in the commercial real estate market. Dubai World has some of the world’s premier properties under its control, including the world’s largest skyscraper and a series of man-made islands that resemble a palm tree and a world globe. Such things do not come cheaply. And they only have a limited application in terms of profitability. But if they go belly up, and are allowed to fail, that could make the sound of the “other shoe dropping” in the real estate venue. And considering that Abu Dhabi just gave Dubai a $10 billion bailout back in February, they may not be so anxious until some other pressure is applied.

Of course, the $60 billion of debt that Dubai has racked up is just a drop in the bucket compared to the TRILLIONS (that’s with a “T”) that have already flooded the market from other stimulating economies. David Buik, an analyst at London-based BGP Partners, figures the trouble in the UAE won’t amount to more than just an “unfortunate public relations exercise by Dubai.” We shall see how this unfolds and whether or not the ripples dissipate or turn into bigger waves.

And we’ll keep that in the back of our minds as we explore the news elsewhere around the globe.

Until next time,
Bill Jenkins

December 3, 2009

Understanding Dubai’s Debt Problem was originally featured in the Penny Sleuth.

They’re talking about the series of calculations that are used to determine the value of options. The calculations are designated by various letters of the Greek alphabet, from which they get their name.

On our agenda today is delta.

Best known as the fourth letter of the Greek alphabet (or seen in movies followed by the word “Force”), delta represents change. In options, that means the rate of change in the value of an option as related to the underlying instrument.

I know that seems like a mouthful, and it is, but bear with me and it’ll make a lot of sense shortly. (Plus you’ll sound like a genius among your friends.)

Every option, whether call or put, has a delta attached to it. Generally you can find this information on your broker’s Web site.

A call has a positive delta, and a put has a negative one.

If an option is at the money, usually the call option will be a delta of +.50 and the put option will be -.50.

Thus, if the GBP/USD is currently trading at 1.6400, the 1.64 call option has a delta of +.50 and the 1.64 August put option has a delta of -.50.

As the pair moves up in value (that is, the sterling appreciates against the dollar), the sterling calls will increase in value. As of this writing, they are trading at $2.51 x $2.63. With the delta at +.50, that tells us that for every penny the sterling increases in value (which would be measured as 100 pips), the option will increase 50 cents. Thus the delta is the measure of the rate of change in the value of the option as compared to the value of the underlying asset.

The reverse is also true. If the spot price fell 1 cent, or 100 pips, the value of the put option would increase by 50 cents.
We also have another inverse relationship to consider. If we are holding put options and the spot price increased, the value of the put option would FALL by 50 cents. Same is true of the call. A 100-pip or 1-cent decrease in the underlying spot price would make the option fall by 50 cents.

So if the pound is at 1.6400, and we are looking at the August 1.64 calls, let’s say we go ahead and we buy them right now at $2.63 ($263). We believe the sterling is going to rise and the options are going up in value. If the spot price goes to 1.6500, we can expect the call option to move up 50 cents in value to $3.01 x $3.13, giving us a return of 38 cents per position.

However, at that level, the delta has changed (actually it always changes as the price changes, but for the sake of simplicity we won’t go into that detail). At this point the delta is nearly +.60. So now for every cent the spot moves up, our option will increase by 60 cents. By the time that the call option is deep in the money, it will have a delta of 1.00. That means that for every 100 pips, or 1-cent move, in the spot, the option will move a corresponding 100 cents. The same is true for a deep in-the-money put. It will eventually reach its maximum delta of -1.00, at which point it will move in lockstep with the spot price.

How does this help us? Mainly in terms of entries and exits that we would like to plan in advance.

Planning Moves with Delta

Let’s go back to our British pound calls. When we last left them, we were at the purchase price of $2.63 ($263). We know that for the price to break even, we must see the underlying spot price move to 1.6663 by expiration. If it moves up, but less than $2.63, our position will be worth something, but it will still be a loss.

If we want our position to double, we can use delta to make the following calculation. A 1-cent move will increase our value by 50 cents to $3.13. Another 1-cent or 100-pip move will increase our option value by 60 cents to 3.73. That increases our delta to .65. Another 1-cent or 100-pip move will take us to $4.38.

That takes our spot to 1.6700. It is now 3 cents (or 300 pips) above our strike price and is valued with an additional $1.38 in time value to make up the whole price of $4.38.

If it never moves another pip or penny until expiration (where time value is zero), we would still have a 37 cent profit on the option – that’s simply taking the 3-cent or 300-pip move on the underlying spot and subtracting out our original $2.63 entry price.

But back to our example, we still have some time value and we are aiming for a double. Thus we need the option price to end at $5.26 ($526) or higher. At this point, our delta has reached +.70. Thus another 1-cent, 100-pip, move adds 70 cents to our $4.38 to make it $5.08. We are now only 18 cents shy of our target, and our delta has now risen to +.78, so we only need a move of 23 pips to get us to our target.

We have viewed a move of 423 pips (or approximately 4.25 cents) to produce it. But that isn’t all that goes into the equation. Time value has also deteriorated during this process and added some volatility.

Nevertheless, we can use delta to estimate our profit targets and keep them in line with current underlying movements of the market.

Hope that clears up some of the mystery about these Greek terms you hear tossed around.

Until next time,
Bill Jenkins

August 3, 2009

Make Profitable Market Moves Using “Options Greeks” was originally featured in the Penny Sleuth.

But some things provide “reasonable markers” to see what a currency is doing. One of my “favorites,” although I hate to call it that, is the “civil unrest factor.”

Across the Eurozone escalating economic problems and disagreements between members and neighbors have touched off riots and outbreaks of violence. People involved in civil unrest are a multifold problem. First, they have too much time on their hands because they are not working. Jobless citizens, especially in a heavily socialist culture, are a continual drag on the system. Second, it costs money to keep repressing social upheaval — presenting another drag on the system. Additionally, the passions and fears of men being what they are, such activities tend to draw in more normally productive folks as the snowball gains speed and volume.

Here in the United States, we are not facing such difficulties (yet). This means a more reasonable system of work and distribution of goods and labor. All in all, this is good for a culture, the body politic and the economy. As a result, it also breeds greater confidence in the currency. And when all is said and done, investment money will go where there is a reasonable likelihood of return, even if the return may be lower.

Specifically, there are several exotic currencies that have offered high rates of return for speculative investors and traders, like the Brazilian real and the Indian rupee, just to name two. But it is difficult to place large sums of money there simply for the sake of the wild swings in value. A high interest rate is no good if the principle of the investment is destroyed by currency depreciation.

This is what has been good up to this point in the recession/depression for the U.S. dollar. And if this continues to unfold over the next year or two in similar fashion, this would still produce U.S. dollar strength compared to the euro simply by the “fear factor.”

Now let’s end with a look at my favorite currency, the Australian dollar.

The Aussie dollar chart looks remarkably like the euro — going back to the beginning of June. All things considered, that’s rather remarkable given the relative strength of the Aussie economy compared to the Eurozone. Nevertheless, fundamentals will eventually rule the day, and though we may have to wait it out a bit, we look for the Aussie to rebound in the future.

One of the difficult parts of the equation at this point is the widely reported and detrimental riots in China’s western Urumqi (pronuonced U-rum-CHEE) province. Ethnic fighting between Muslims and Chinese citizens has threatened to overpower the police force.

As you know, Australia’s success going forward is inextricably tied to China. So worries about riots in one part of the country can certainly be detrimental in other parts as well. Even though the violence in other provinces may not be ethnically related, once a group of people feel they have been wronged and have the sheer numbers to overpower a military or police crackdown, all heck can break loose.

Remember, there is significant fear of unrest all over China as the depression sets in. The people were just getting their first dose of “la dolce vida,” only to have it stripped away. And gone are the days when they trusted their government to provide for them. Now it is beginning to look more like the enemy than a loving “big brother.”

For now, though, the Aussie dollar hasn’t been impacted by the fray. It has been well supported at the 78.25 level. A strong close below 78 on the daily chart would invalidate that forecast, and likely lead to more downside. We’ll just keep our eyes open.

Until next time…Happy Trading!
Bill

July 14, 2009

Why the Aussie Dollar Is My Favorite Currency was originally featured in the Penny Sleuth.

‘Tis all rather foreboding…

Of course, if you’re a government statistician, you probably have a different view of things — especially after the recent numbers oozing out of Washington.

The last time we sailed to together, I predicted the personal savings rate was headed to 5%. Low and behold, we learned this week that it has risen to 5.7%! Looks like I have ESP. I’m thinking about starting one of those 1-900 telephone numbers! (Are they even still around?)

Then on Friday came the job(less) report from the Bureau of Labor Statistics. A lot of people cheered… but only the ones who took the numbers at face value.

The data said that the United States only lost 345,000 jobs. That’s still breathtaking, but after the nearly three-quarters of a million lost just a few months ago, it looks like real improvement.

But you may recall me talking about the mysterious “ghost jobs” that just magically appeared in the last report. Not actual people — just people the government assumes must be working. Well, they’re back to it again! In May they “created” 220,000 jobs (20% of which were supposedly in CONSTRUCTION!). Oh, come on, really?

The backside of the number is not much more encouraging — 3.9 million long-term unemployed (those unemployed for more than six months). The long-term unemployed figures are what will really come home to roost. All these people, on a government-mandated insurance program, surely create an additional drain and add nothing to GDP.

Also, we must not forget those who have “dropped off the radar.” The folks unemployed for so long, they’ve quit looking, quit drawing benefits, and quit trusting in the “Hope” and “Change We Can Believe In.” The total number of unemployed now stands at 14.5 million Americans. Lord have mercy…

Now let’s try this on for size. Remember all the feel-good consumer sentiment indexes that have been rising? Remember how I told you to be wary of them? Let’s take a peek behind another curtain for a clearer view.

Last September, Americans added $6.98 billion in debt to household balance sheets. The three-month moving average for consumer credit was $3.436 billion in August 2008 and fell to $2.886 billion in September. At that point, the terror was coming into its heyday, and it seemed like the world would end and the sun was about to burn out. Americans began their own personal contraction — a spending contraction. They took whatever available cash they had and put it against the tons of available credit balances. In March and April of this year, we collectively paid down $32.2 billion in debt. The three-month moving average for April was -$14.366 billion.

On top of that, as mentioned, Americans have been saving more, too. In fact, the savings rate is at a 14-year high.

Frankly, I suppose that people are feeling better because they have paid down some debt and have a bit more cash tucked away. But either way, they are not contributing to further consumerism.

As for the greenback itself, the U.S. dollar index is now fighting with the 80 level. It has broken below, moved a above and is now heading lower again.

Sincerely,
Bill Jenkins

June 11, 2009

GM Bites the Bullet… Will the Dollar Follow? was originally featured in the Penny Sleuth.

Consider the Treasury International Capital (TIC) flow data. TIC measures foreign investment in the United States. This is important because we rely on foreign investors and sovereign governments to continue funding our deficit spending.

But the most recent numbers show a major decrease — $23.2 billion in March, versus an outflow of $91.1 billion the previous month. That will put Ben Bernanke and his boys in an even tougher spot.

Here’s our pal Chuck Butler from EverBank weighing in on this. “There are two ways they can try to entice these foreign investors back into the U.S. Treasury market. They can either let interest rates increase, or let the value of the U.S. dollar fall.

Now which do you think they will choose? They have been running the printing presses on overdrive in order to try and keep interest rates down to create another refinance boom. That tells me the Fed will try to do everything they can to keep interest rates down, so their only option is to let the U.S. dollar fall.”

The drop in TIC flows, combined with a huge increase in funding requirements by the United States, will have to lead to a general debasing of the U.S. dollar.

That’s not to say things are better on the other side of the Atlantic. The Eurozone (EZ) unveiled some nasty economic news last week.

Let’s start with the real engine of the EZ, Germany. Its first-quarter 2009 GDP number showed a contraction of 3.8%, worse than forecast, and the worst figure since 1970, when these records began. Annually, they are looking at a 6.7% contraction, another record.

In the last nine months, Germany has squandered all of its GDP gains accrued since 2005.

Right on their heels, the EZ composite stats showed a 2.5% GDP drop for the quarter. Again, annualized, that comes in at a 4.6% drop… both of these numbers are records, too.

Expanding our horizons just a bit, we see that Spain continues adding fuel to the fire. Even though Standard & Poor’s has already cut the country’s credit rating, the Spanish folks unveiled their worst recession in four decades. GDP shrank 1.8%, after a 1% drop in the last reading. A year ago, GDP was 2.9% higher. It isn’t a record number, but you’d have to go back 40 years to find something similar.

How much further can Spain fall (and Ireland, and Greece as well) before the euro enters crisis mode?

The truth is, we’ve never been down a road quite like this one. So the map we have is out of date. But there is one thing it can tell us — there is a cliff and a gorge ahead. We just can’t tell how far away it is, or around which bend we’ll find it. No matter, we’ll keep the pedal to the metal, so at least we can make good time getting there…

Adding to the loud accelerating noise in the Eurozone this week, Reuters reports that the European Central Bank (ECB) “has rejected several Central European central banks’ request to accept local currency bonds as collateral,” according to Hungarian central bank’s Kiraly.

Remember that the ECB adopted quantitative easing (QE) — buying bonds — some weeks ago, but there was a significant dissenting vote. Germany’s central bank, the Bundesbank, the most influential in the ECB, was completely against QE.

Axel Weber, the Bundesbank’s president, said, “the ECB has done enough to help the economy and shouldn’t consider further measures unless things get a lot worse.” He added, “The ECB doesn’t see the risk of a broad credit crunch or deflation in the euro area.”

I’m pretty sure his counterparts in Spain, Ireland and Greece will take umbrage at his position.

As I’ve written before, the bureaucracy in the EZ makes these decisions and policies tough to carry out. ECB President Jean-Claude Trichet is going to have to work out some kind of ceasefire between the factions. Which means they still have no concrete plan to stimulate anything other than infighting. While this is happening, the euro is speeding closer and closer to the cliff.

Sincerely,
Bill Jenkins

May 20, 2009

FOREX Update: The Dollar and the Importance of TIC Flows was originally featured in the Penny Sleuth.