Young's Modulus of Macro Managers

The new job has somewhat distracted me from writing for the past couple of weeks and, to that matter, trading too. Which all in all is probably a fairly good thing. The down side is that those pesky puts I bought for a Ukrainian pop have done what most bought options tend to do - expire worthless only for the next day's move to be in the direction you were looking for. C'est la vie d'options

I am beginning to wonder if 2014 could be rebranded the zero-sum year where nearly every move that has occurred due to positions being entered based on future macro expectations has eventually unwound back to where it came from. If the original move was positional and the unwind was positional (taking us back to the starting point) it does make you  wonder if there is any real non-spectultive business going on, or if it is naturally netting to zero. If so then perhaps we are at a proper equilibrium and the noise is a veneer of speculative positions waiting to reverse. After Zombie banks perhaps we have Zombie Markets and perhaps we should all go and join this wonderful event in a couple of week' time. No, It's not a macro manager's parade but it looks similar.

So the tension in the markets is palpable as general ideas and trades are not generally playing out made all the worse by a healthy dose of 'Meh' where what would have been market moving news events are, due to the anaesthetic of past performance of panic trades, yielding performance of zip. This is putting stress upon macro funds where returns continue to be dismal and I can only imagine that the pressures  might start creating behaviourally bias. Macro managers are feeling the stress of lack of performance and the strain of cost bleed and justifying their existance to their investors and CIOs so we could ask, referring back to schoolboy physics, "What is your Young's modulus?"

It would be wonderful to see an E measure appear as a behavioural input into a consultant's measure of a fund manager's investment process.

And on to lighter things - Did you hear the one about the banker, the consultants and the German client? The story is one of lines of responsibility being blurred by a bill for strippers which, though of course is an important issue it, will be probably be scaring the bejessuz out of many an institution if there is a chance that past client entertainment in gentlemen's establishments will deem subsequent deals Ultra Vires!

The backdating of current ethics to cover past histories rolls on.

Ukraine Quiz

It's a bank holiday here in the UK so time for some questioning on Ukraine. Some lighthearted and some not.

Where is the Ukraine?

- Southwest of Russia bordering the Black Sea and rest of Europe.
- The west is in Europe and the east is in Russia.
- It's a town in mid-west USA.
- Up shit creek without a paddle.

Does the Ukraine situation matter to the global markets? 

- Ukraine does matter - Prices are being held back even though at highs so if resolved will fly higher.
- Ukraine does matter - But Western policy will be enough to deter any further Russian actions so prices are marked neutral.
- Ukraine doesn't matter - So no market impact.
- Ukraine may matter or not, but even if it does matter we've seen all bad news result in higher prices anyway over the last few years and Ukriane has nothing on CB policy impacts so back to Fed watching.

Is Putin -

- A man resurrecting Russian glory that has been castrated by the west.
- Just cunningly using the provoked Western sanctions to smokescreen a failed domestic economic policy.
- Doing a "North Korea" and using military scaremongery to negotiate better terms for Russia elsewhere.
- Really truly only just working for the best interests of his countryfolk in Ukraine.
- Dr. Evil.
- All of the above.

Is the West -

- Convinced that sanctions will win the game.
- Prepared to use military force if it doesn't.
- Of one voice.
- Of one intent.
- A diaspora of individual interests incapable of coordinated action beyond the vague, platitudious and marginally ineffective.
- The X-men.

If you were brokering a land deal between Ukraine and Russia would you -

- Uphold historic political boundaries though only go back to the 1950s.
- Uphold historic political boundaries going further back and invoke Mongol hoards.
- Offer Crimea and some Eastern Ukrainian towns to Russia conditional upon them also taking back Chernobyl.
- Suggest a good marriage councillor.

- Have it decided in a 3 year running Saturday TV talent show hosted by Simon Cowell and make a fortune on the phone vote charges. 

If you were voting at the upcoming Ukrainian presidential elections would you vote for - 

- The boxer fellow though he says he won't stand.
- Julia - she's fit.
- Von Rompuy.
- Obama.
- Farrage.
- Whatever the only box on the vote slip says (usually 'Mr Putin').
- I dunno it's all too confusing.

If you owned a successful company in the Ukraine would you -

- Be glad of a falling exchange rate as it's making your exports more competitive.
- Pack up all your assets into containers and set sail down the Dnieper in the middle of the night for Bulgaria.
- Laugh at the west freezing $100m at JPMorgan of your $7 bio wealth.
- Hoist a Russian flag.

If you have a holiday river cruise on the Dnieper booked do you -

- Cancel it.
- Go anyway, it can't be that bad and anyway the exchange rate is making it cheaper.
- Take some pepper spray just in case.
- Camouflage up as you are actually a part of a GRU special force planning an infiltration raid on Kiev.

Which, if any, do you dispose of when found in your sock drawer -

- A signed photo of the time you were awarded an honour by Mr Putin.
- A letter you had penned but not sent to the Times  praising Putin for his Westernification of Russia.
- A wad of 2bio Rubles that a 'friend " had asked you to look after.
- The tickets to meet your internet bride in her home town of Donetsk
- The spare phone you reserved for slagging off Russian policy to your mate Edward Snowden.

if Ukraine were a fish what type of fish would it be (hat tip to social media style questionnaires) -

- A pilot fish.
- A lamprey.
- A puffer fish.
- A kipper.
- Nemo.

If Ukraine were a tea towel what type of tea towel would it be -

- A nice new blue and yellow striped one.
- A blue and yellow one with red stains.
- A red one marked "return to manufacturers for cleaning".
- A picture of an idyllic village printed on material so thin you can see through it.


And finally - If Ukraine were an enzyme which type of an enzyme would it be -

- Ethanukraniase - Breaks down Ukrainians in the presence of alcohol.
- Ukraniase - Breaks itself down in the presence of Russians.
- Euroase - Breaks down European union in the presence of decisions.
- Putinase - Breaks down Russian resolve in the presence of sanctions.
- Oscarpistoriase - Just breaks down.

Carry Creep and Risk Reversals

One of the characteristics of carry trades which extends through to many emerging markets and even the quiet function of equity markets (never sell a quiet market) is their tendency towards "carry creep". In absence of all other information prices will generally creep on up as the carry benefit of either interest rate differentials or dividend payments makes them continually more beneficial to own than the alternative. But the question is always how far can price go up before it outweighs the carry advantage.

With respect to equities, yields fall with price rises to naturally stabilise the price rallies around some sort of equilibrium - unless the function of future expectations swamps yield differentials and we head of into another reasoning that ends up as it happens with the same price action.

But with FX the interest yield differential is maintained no matter what the entry price is. The self levelling function then is dependant upon a more complex route of the secondary damage of runaway FX rates to core economies which has a natural lag involved. That lag is when things start to heat up and a prime example is the Aussie Dollar where yields were being driven by high rates maintained to control an economy booming on the back of mining during the commodity boom. It led to the central bank wanting FX rates lower but the currency only really fell once the China slowdown hit future mining outlook and the risk of holding the carry was felt to be greater than the benefit. At which point the carry trades started to unwind as price volatility vs return thresholds were tripped.

But in general without any other external inputs FX will be subjected to carry creep before an exogenous shock trips prices dramatically lower with carry unwinds accelerating the pace. So though the total price rise as money goes in will, all else being equal, equal the price fall coming out, the pace will be very different. And hence we get our classic sawtooth price action.

But how do we play a sawtooth? If there is, for example, an 80% chance of making 2.5% on the up creep but a 20% chance of losing 10% on the down fall then the game looks pretty flat. But things might be different if you use options to take advantage of speed differentials and the use of risk reversals has always been a conceptual favourite of mine when it comes to trading carry creep. With the idea being that you pick a shortish period, say a week, and extend the carry creep line that price has been following to the expiry date and sell a call with strike above that line and meanwhile buy a downside put for the same premium you receive. A zero premium risk reversal. This will either hopefully expire within the strikes and not have cost you anything, or in the case of the dump, have smashed through your lower strike leaving you a tidy profit. If it hasn't paid off and price is higher but within strikes at maturity just reset with new higher strikes. Something like this

But there are some naturally self limiting functions that will undermine the benefits. First that you will be pricing against the forward which if the yield is high (why you are going in) will mean that the stretch between call and put strike is already against you and then there is the function that you are probably not the only person to work this trade out and the market is already pricing it away. In equities puts always tend to price over calls and the example is interesting in AUS where a put bias was dramatically present all the way up to the point that some were arguing that as AUS was no longer an emerging currency it didn't deserve to have puts so skewed over calls. As it turned out - it did. But this was more due to its carry component rather than any other EMness (though of course the ability to liken Australia to an EM is often too great for a Brit to resist).

But despite the normally skewed pricing, it could well be flatter than your fears and as an alternative to running carry costs directly against yourself via a cash short, this might be an alternative. It is certainly worth looking at when you have the saw-tooth dilemma worrying you that though the trend may be your friend it might be about to run off with your wife.