Edition 16: Hedges and bets
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Top of the news
The U.S. economy added 245,000 jobs in November, the smallest number of jobs added in seven months. Permanent job losses in the U.S. since the beginning of the pandemic stands at a staggering 3.7 million.
Salesforce confirmed its intentions to purchase Slack for $27.7 billion; Slack’s stock is up 58% since a month prior; Salesforces’ down 13%.
Bitcoin continues to rise to meteoric highs, and is trading at 19,384.40 per, near its all time high of 19650.01 set back in December 2017.
The UK is the first Western nation to authorize use of Pfizer/BioNTech vaccine for distribution to the population. Meanwhile, Pfizer slashed its manufacturing target by half to 50 million. Pfizer stock remains up about 6% for the week.
Betting odds exchange Smarkets pegs Brexit negotiations will be resolved by end of year at 66.7% as of this writing.
Meanwhile, deadlock between Republicans and Democrats continues over a $908 billion economic stimulus package proposal; the latest timeline for a vote to work out this year would be December 9th.
Warner Brothers announced it will release 17 movies -- its entire 2021 slate -- simultaneously to movie theatres and its streaming service HBO Max; previously the minimum run time for a movie before going to streaming was 17 days.
From /r/accidentalrenaissance: “Traders work on the trading floor of the open outcry pit during the last ever session at the London Metal Exchange, London, 27 January 2016. The historic trading ring, the only one of its kind in Europe (and possibly the world), was set to move to new premises on 1 February 2016 after 11 years at its current location in Leadenhall Street. Photo by Adam Gray.”
BNPL is really interesting -- or scary
The holidays are a time for shopping for gifts, and this year’s shopping seems particularly worthy of the small personal / exercise / gadget splurge. But with limited incomes because of the pandemic there is a newly popular payment phenomenon called Buy Now, Pay Later (“BNPL”), currently being shored up by companies like Klarna, Affirm, Afterpay, SplitIt, Quadpay and even recently, PayPal. They’re the modern evolution of layaways (“laybuy” in the UK), made easier by one-click solutions without any judgment or scrutiny beyond a basic credit score check. Scarily, unlike layaways, customers get their items up front; further, some merchants offer it with zero interest by offsetting the fees themselves (anywhere from 2-8%), hoping to pick up more traffic in doing so. Consequences for not paying on time include the typical fees and the balance going to collections.
The obvious drawback is the fact that it becomes terribly enticing to spend beyond one’s own means. It seems also likely that given today’s low interest rates, very few can really meaningfully “game” the system by keeping any payment not made on day 1 towards an investment or savings account thereby effectively paying “less” for the item through some dividend over the longer-term.
Peloton and thousands of other businesses offers BNPL
The most fascinating insight is that most of the BNPL firms are operated and listed outside of the U.S. Both Afterpay, Quadpay and SplitIt are all based in Australia; Klarna is based in Sweden. Affirm just filed for an IPO. Amazon has really not gotten into this space, except with a small partnership with Citi for owners of a Citi-branded credit card. There is considerable downside risk to what are effectively loans to consumers; the future of this space remains very murky.
If this topic fascinates you may I recommend reading “The Unbanking Of America: How the New Middle Class Survives” by Lisa Servon.
Start reviewing tax implications if you worked from somewhere other than the state you’re in
There’s a tax policy in the United States called the “convenience of the employer rule” which stipulates different rules for remote workers based on whether or not they moved due to necessity or convenience. If it’s the latter, in certain states like Connecticut, New York, Pennsylvania, Arkansas, Delaware, Nebraska and even Massachusetts, people who now work from outside these states may still be taxed as though they are simply because their offices are registered there. By way of example, an employee who worked in an office in Cambridge, MA who, since March has been working from New Hampshire (where there are no income taxes on wages and salaries) will be taxed as though they had never left.
The short of this is that if you currently work from a country or state other than where you used to, it might be a good time to a) catalogue your days in each state this year and b) review your tax implications, perhaps with a CPA. This long summary from AICPA may be a good start.
Puts and calls, Bitcoin and Robinhood
There’s a small side of me that has always been fascinated with bets and odds. A long time ago I went to Macau and visited some of the largest casinos on my own 88 days in APAC trip (I didn’t spend a dime). I still like the silly thrill of scratch cards and lottery tickets (aka the “tax on the poor”). And I absolutely know I cannot get myself into options trades and speculative cryptocurrency trading.
But! It’s a nice exercise to at least learn about these, no? So let’s dive right in (and yes, the following is a very simplified narrative).
Options trading is by far the easiest way to earn a lot of money at once and also to lose it all, and 2020 has been a banner year for options with all the volatility in the market. In fact, 9 out of the 10 of the busiest days in the entire history of the options industry going back to the 1970s have happened this year.
An option is a contract -- or more of a bet -- that allows the holder to buy or sell a stock at a certain price and at a certain date. It’s a derivative market because it’s betting on the direction of the stock’s price (on the other hand a primary market is you buying or selling individual stock). You purchase a put option if you think the stock will decrease, and you purchase a call option if you think the stock will increase.
So, for example, let’s say I have a feeling that Tesla will increase from the bonkers price of $599.04 today to $630 (or more) within 2 months. I can purchase an option (typically equivalent to 100 shares) that expires in 2 months from someone who thinks that’s really unlikely to happen. I might buy a call option for a strike price of $615 that expires in two months for $5 per share (the premium), or at a cost of $500.
Now if the price of Tesla were to increase to $630 before the expiration date, then the $5 I’ve paid is now worth $15 ($630 - $615), which means:
I can choose to purchase my Tesla stock back at the price I promised, at $615 per share, so if you were to immediately try to turn around and sell them you would net a ($630-615)*100 - $500 = $1000 profit.
I could sell my contract on the open market to someone who wants it, for the price of ($15 gain - $5 cost) or $10 premium * 100 shares or $1000.
Note in both scenarios your maximum profit here is $1000.
Now if the price of Tesla were to actually dip to $560 by the time my contract expires, no one wants my options and it’s worthless, so I lose the $500 (the buyer has made the profit here). A put option is more or less the inverse.
In the example above, it seems like the potential wins outweigh the losses. How is it then, that a study in the late 1990s by the Chicago Mercantile Exchange (CME) found that a little over 75% of all options held to expiration expired worthless? The profits on an option really depends on the premium, which is going to vary depending on who is willing to take you up on your “bet”. If it looks dead obvious that Tesla will trade at $630, then no-one would be willing to give you just $5 for your $615 strike price call. The concept of forecasting the magnitude of the price swing of a stock is called implied volatility, and is factored into the cost of a premium.
The other thing to consider is when someone would want to sell their contract on the open market before it expires (this is called the “time value”). If Tesla were to reach $630 within a month, then there’s one month remaining on the contract for the share price to move around, so someone would be willing to buy it from you. And no, sadly, options cannot be extended beyond their expiration date. But if I want to sell my contract the day before it expires, and the prices of the stock is still $630, no one will be willing to buy that contract from you because it’s a definite loss, so your contract expires and you end up having to buy all the stock at $615 per share or a cost of $61,500. It’s still a profit, but requiring you to hold the underlying asset.
If you want to invest using options, I highly recommend reading this guide and many more before doing so. If you *are* already buying and selling options and you’re doing well, please let me know! I’d love to share with everyone.
I seem to have run out of both time and space to discuss speculative cryptocurrency and general market hedging. It’ll have to be another time! Thanks for reading!
Back editions at marketinsight.substack.com! Errors above are my own.
Rio
Rio Akasaka is not a registered investment, legal or tax advisor or a broker/dealer. Although best effort is made to ensure that all information is accurate and up to date, unintended errors may occur. Past performance is no guarantee of future returns. Always seek financial advice as needed.