Trust

Robert F. Kennedy Jr on the Collapse of Trust in the Government & Media

“When my uncle left office in 1964, 80% of Americans trusted the government and even more trusted the media…Today 22% of Americans trust the government and those are people who I would say are not paying attention.”

Trust is essential to a functioning economy. Inflation and hyperinflation are symptoms of a loss of trust.

Volatility Suppressed

For nearly three months now, 0DTE (options expiring within 24 hours) players have suppressed volatility. Any intraday increase in VIX is quickly met with mean-reversion trading of options which effectively counters all but the strongest of trends. The problem with this is that suppressed volatility eventually breaks out of its cage. The last time this happened was in 2018, and the event is now called “Volmageddon” or “Volpocalypse”. VIX doubled in a short time, which was not too serious for the major indexes but wiped out a number of leveraged VIX-related ETFs. This time the potential risk is much larger because the volatility suppression is really a side effect of an options strategy which is able to directly cause a major move. JP Morgan estimates that a 5% move in the S&P would trigger a further 20% crash as the options writers moved to hedge their positions by selling stocks and futures. But to further aggravate the situation, the open interest in VIX calls is at an all-time record as some traders believe this suppression cannot last indefinitely, and will blow up at some point. A sudden rise in VIX would cause these calls to create a gamma squeeze in VIX, driving VIX still higher and increasing the selling by the options writers. More than $1 trillion notional of 0DTE options are being traded every day. This is idiocy. The selling would be entirely automated, just like the “portfolio insurance” that caused the 1987 crash.

OTOH there’s a lot of idiocy around right now. A clue is that “Mr. 50 cent”, a very large and successful VIX options trader known for the signature habit of buying large quantities of options for, well, 50 cents, has taken a call position. This person (or fund) is not an idiot and has been absent for a while, after racking up an estimated $200 million profit in the 2018 event. In all fairness that $200 million was actually a $400 million profit offset by $200 million in losses stemming from being early. That’s conviction.

Crypto Crackdown

The SEC is making headlines as it has fined cryptocurrency exchange Kraken $30 million and forced it to shut down its crypto “staking” operation.  According to the SEC, Kraken had $2.7 billion worth of crypto in the program, earning Kraken $147 million. Coinbase CEO Brian Armstrong has commented that the SEC was looking to “get rid of crypto staking in the U.S. for retail investors”. Coinbase has a similar operation called “Earn”, so I looked to see what Coinbase has to say about “staking.” 

As far as I can tell you turn over your crypto to Coinbase, which then either turns it over to a third party to use as “proof of stake” or uses it on its own crypto servers for the same purpose. Coinbase does not assume any of the risks involved. Proof of stake is essentially a security deposit required of anyone who wishes to participate in the validation of new blocks on certain blockchains – which earns a share of the transaction fees or “gas” paid by users. Faults such as validating a fraudulent block or going offline may cause the stake to be “slashed.” And that means your crypto goes bye-bye.

This is unlike, for example, a bank deposit where your account is an obligation of the bank, not related to any lending activity of the bank. Losses from defaulting borrowers are charged against the bank’s capital account, not depositors’ accounts. The bank’s capital is backed up by the FDIC or FSLIC. I presume this is the basis for the SEC’s position. Seems to me a very modest return for an unknown risk, especially when compared to short-term Treasury securities.

Lehman II?

The second-largest crypto exchange, FTX, has halted withdrawals and appears to be bust. Formerly valued at $32 billion, one must assume that it is now worth a lot less than that. The largest exchange, Binance, negotiated a non-binding bailout agreement and then withdrew it after a look at the books. I wonder if this is crypto’s Lehman moment? The time when the fantasy meets hard, cold reality?

Edit: FTX has/had more than five million customers worldwide. The Miami Heat’s home stadium, named FTX Arena, will be getting a new name. Porn movie producers Bang Bros. tweeted that their 2019 $10 million bid for the naming rights was still good, and they added that they promised that a lot fewer people would be f***ed.

Clear The Track

Here comes Shaq. Shaquille O’Neal, not Eddie (only older Canadians will understand). Apparently Shaq is “advising” a SPAC that is considering acquiring WeWork, the office space outfit that leases big and long and rents small and short. Yes, that does sound like a formula for high risk and so far that has been borne out by history.

As to the future, if I had to pick candidates for the company least likely to survive the flight of workers away from offices and downtowns, WeWork would be right at the top of my list. But SPACS have to spend the money they raise, or the sponsors can’t collect their share. So it’s panic to buy. Anything, apparently. Selling that deal to the investors, whose approval for the transaction is required, should be an interesting exercise. Popcorn, please. He shoots! He scores?

Shoeshine Boys (and Girls)

Joe Kennedy, JFK’s father, is said to have exited the stock market before the 1929 crash after a shoeshine boy gave him some stock tips. Bernard Baruch, a legendary investor, described the scene before the crash:

“Taxi drivers told you what to buy. The shoeshine boy could give you a summary of the day’s financial news as he worked with rag and polish. An old beggar who regularly patrolled the street in front of my office now gave me tips and, I suppose, spent the money I and others gave him in the market. My cook had a brokerage account and followed the ticker closely. Her paper profits were quickly blown away in the gale of 1929.”

It seems that the Robinhoodies and their ilk are the modern equivalent. It is interesting how their strategies have changed, from simple individual daytrading to semi-organized crowds pursuing sophisticated options strategies such as gamma squeezes, then on to short squeezes. “WallStreetBets” subreddit seems to be one of the main cheerleading tools, with two million members and who knows how many lurkers. It does seem that the squeezing is as much a power trip as it is financially motivated.

Don’t get caught out in the storm. At least not without protection.

Bitcoin has a bad case of the sags as the Hoodies are busy pumping small caps in order to squeeze or blow up the hedge funds shorting them. The FOMO mania is gone. The exit door is still open but those doors have a way of slamming closed in an instant.

Remember that in a real crash, like 1929, many stocks go completely bidless.

Robin Hoodies Attack Sheriff

Today’s sudden collapse at 10:45 was, in my opinion, likely to  have been a forced liquidation of a large position, very possibly a small hedge fund, to cover a margin call. One can imagine that it was a victim of the vicious short squeezes being led from Reddit, where the Robbing Hoodies use their stimmie-sourced buying power to squeeze short positions in smaller stocks where there are substantial short positions.

There is already one major casualty of this process, per zero hedge:

Melvin Capital, which we learned last week had suffered massive losses on its shorts, is set to receive a $2.75 billion capital injection from hedge fund giants Citadel and Point72 and investors (in what appears to be a bailout so Mevlin Capital founder Gabe Plotkin, a former star portfolio manager for Steven Cohen, could pay his margin call)

This is just another symptom of the broken market created by the Fed. If they don’t rein this nonsense in pretty soon, the whole thing is going to blow up in their (and our) faces. Idiots.

Market manipulation, by the way, is illegal. But the SEC only goes after sitting ducks, small ones at that.

SoftBank Is Back

Apparently SoftBank spent $200 million on calls in the big tech names yestrday, preparing another gamma squeeze such as the one that is used to drive the market up in August.

Will the dealers or the regulators let it get away with it again?

Bucket Shop

By the 1880s the electrical telegraph system, that began to be deployed in the 1840s, had been adapted to the distribution of stock exchange prices. Ticker tape machines provided a continuous stream of quotes printed on paper tape at about one character per second (whence the “ticking” noise).

Access to actual trading on the stock exchange was expensive and limited to those with substantial assets, but people of lesser means wanted to speculate. So the “bucket shop” came about. The bucket shop provided a means for customers to bet on the fluctuations of stock prices, as shown by the ticker tape, without the expense and delays of actual trading. However, the business practices of the bucket shops made it very difficult to succeed, but not impossible, as shown by famous speculator Jesse “Larry” Livermore who made his first $1,000 at age fifteen (1892).

The terms of trade varied among bucket shops, but they typically offered margin trading schemes to customers, with leverage ratios as extreme as 100:1 (a deposit of $1 cash would permit the client to “buy” $100 in stock). Since the trades were illusory and not settled in the real market, the shop likewise made no real margin loans, but did collect interest in cash from the client. The client could easily imagine that he had been loaned a great sum of capital (in fact an illusion) for a small cash deposit and interest payment.

To further tilt possible outcomes in their favor, most bucket shops also refused to make margin calls. The elimination of margin calls was portrayed as a benefit and convenience to the client, who would not be burdened by the possibility of an additional cash demand, and touted as a feature unavailable from genuine brokerages. This actually made the client more vulnerable to a heightened risk of ruin, with the losses flowing entirely to the bucket shop. In this situation, if the stock price should fall even momentarily to the limit of the client’s margin (highly likely with thin, highly leveraged margins in volatile markets), the client instantly forfeits the entire cash investment to the shop’s account.

Margin trading theoretically gives speculators amplified gains, but trading in a bucket shop exposes traders to small market manipulations due to the shop’s agency. In a form of what is now considered illegal front running and self-dealing, a bucket shop holding a large position on a stock, and knowing a client’s vulnerable margin, might sell the stock on the real stock exchange, causing the price on the ticker tape to momentarily move down enough to exhaust the client’s margins. Through its opportunistic actions, the bucket shop thereby gains 100% of the client’s investment.

Today, “bucketing” is illegal. However, the Robinhood brokerage which has attracted so many small traders has retained many of the features of the bucket shops. Robinhood attracts the young and naive using video game and slot machine ideas. Instead of putting the trade “in the bucket”, it sells the orders to high-speed traders. To complete the model, Citadel, the largest of these has just been slapped on the wrist and fined for front-running and failing to display customer orders. Sound familiar?

Loose Cannons

In the days of fighting sail, the ship’s main armament typically consisted of rows of cannons lined up on each side of the ship. These cannons fired through ports in the side of the hull and were mounted on wheels so that they could be pointed and able to recoil when fired. Normally, they were constrained by heavy ropes. But from time to time one or more would get loose. Each cannon could weigh as much as three tons and would then roll around the gun deck as the ship pitched and rolled, crushing anything or anybody in its way. The gundeck would be crowded most of the time – each gun on a large ship had a crew of 14 men who not only worked but ate and slept near their gun. Needless to say, a loose cannon could do much more damage than any broadside from an enemy ship.

In the market, the black boxes or “algos” are the equivalent of the loose cannons of yore. They are out of control and roll around in herds, as many of them share similarly programmed rules. You can watch the “herding” in the stock market by watching the “Tick” as it moves to extremes in both directions – that’s the herd. You hear about “flash crashes” – that’s a herd of algos running over some security or asset class. They pose a huge danger to the financial system, and need to be reined in. The mistake that the regulators make is to only consider them as single entities, without comprehending the emergent phenomena arising from unintentional herding behavior.