What a night session here for us in Asia!
First of all, we’re getting the strong levitation across markets – Europe up more than 2% across all indices, the S&P500 in tow at 1.5% and EUR/USD at +0.5% following a fairly stale market in Asia save for the previous “feed me, Shirakawa!” cry from likely premier Shinzo Abe causing a rally of the Nikkei 225 of 1.4% held throughout the day.
In other markets gold is up 1.1% (technicals coming, I’ve had a while needing to reorganize my default charts) and oil seems more like rocket fuel at 2.5% up even though geopolitical tensions were easing from “War” to “Systematic but isolated mutual attacks at high frequency” in the Middle East.
That’s fine and dandy, but what if we can’t trade it?
Patience, grasshopper. Here’s how, and why, and under what exit conditions I will be entering the Hong Kong market later this morning:
First of all, we are finally getting some traction for the VHSI indicator, to the point that I am willing to use it. Here’s a one-year chart. (It pops up in a new window so you can scroll and switch windows at your own leisure, and the formatting is pretty bad for this website given how large it is.)
Static support and resistance:
Beautiful triangle pattern. Take all candles, disregard the highest 1% closing candles relative a trend line going diagonally down, and what do you get? Pretty perfect linear decrease of the volatility peaks. The supporting level initially was 18.5% which got tested 5-7 times, depending on your sensitivity, before breaking following QE3. Someone said technicals are bogus?
We’re in a slightly upwards sloping 15-17% channel, which is clearly moderated by the 21 and 63 day SMA bands. We’re looking at a close below the 21 band and rejection of the 63 in the previous weeks, so there is very much in favour of the volatility still going down to 15%, if not lower.
Now, observant minds might think: “Moron, it’s volatility, this sort of statistics doesn’t work given shocks and jump risks.” I would be willing to agree, but here’s where the studies are coming into play.
Technical Studies Signals:
First, we have a MACD convergence lower in negative trend and just got the ADX/DMI cross in low trend down as well. This is important regardless, and is a good way to allay fears that the volatility performance skew won’t come to haunt us. Both stochastics and RSI signals are giving us signals signifying lowered volatility and in a profile that is very similar to other short-term rallies shown on the chart. In short – everything backs us up!
Some might still, with good reason, contend that an 18% nominal volatility fall trend over a year is clearly unsustainable over the next year when the nominal level is below 17%. I agree completely. Still, a 15% level of volatility would indicate a strong next run, and it’s questionable if not 13% is within reach if China’s growth starts accelerating again and the US can in some way keep together. Still, the fiscal cliff in the way it is structured leaves a best case scenario I believe of a fiscal drag at 1-1.5% of GDP, and given growth prospects in Europe, this is likely to put the US into negative growth meaning QEternity adds Op. Twist to it by not sterilizing via short-end sales which would have a higher incremental impact on the money flow into yield-y assets. Read: Chinese assets as earnings are looking juicy around 10.x P/E.
This trend will break, and when it does (I would say either the Japanese new budget year or the US actual debt limit being approached, 3-4 months from now, meaning -4-6% volatility, indicating a push down towards the 10% level) given the volume of the HSI at these times, it will be forceful! Considering the level of the HSI for this to happen however, I would venture a guess around 23 000 – 24 000 at least. Given the cheapness of options, anything at -13% and +23 000 is therefore a clear buy of long-term OTM puts. Making an anecdotal case volatility took a multiple of .72 at the last leg up, going from 21.5 to a triple-tested 15.5 in two months, making a 3 000 point HSI run. a similar situation from here to sub-13 consolidation would put the index at 24 000.
Before these peaks, however, we would be left with 2-3 months of rally. Thus, a high beta strategy (either pure, leveraged by shorting low beta or index, or fueled with options gearing) becomes imperative to enjoy the move. China-play inflow exposure (property, casinos, HKEx, mainland financials due to growth) would be my main targets, and to some extent also the resource companies. If you’re active, look towards high volume trades with high or expanding historical volatility simply on the premise of technical trading. If you’re passive, act on companies which have the highest level of free cash flows at the moment relative to debt and investments or operating expenses, as they will be slightly less speculative and will allow you time to move out. Another benefit is these companies also being able to enjoy the surge of capital directly as it hits shore, being likely to give you more of a fundamentals effect.
Options are cheap overall, and cheaper still on the upside although by a smaller skew than normal. I will try to catch the market running with slightly less risky shallow ITM options and compensate for the reduction in moneyness risk by targeting high-beta and reducing the time frame to roughly 4-6 months, by which time they will have been long sold.
Put options accumulation begins at -13% and anything in the index at above 23 000. These will be longer term to enjoy the term spread in case of a continued run, and to give the expected strike price approach plenty of time to be re-reflected into volatility skew. Selected instruments are more likely to be HK-focused due to the effects of worldwide trade on Hong Kong, and local financials look like prime targets in this stage of play.
388* HKEx, 27* Galaxy Entertainment, 3988 Bank of China, 1 Cheung Kong. (12 Henderson Land, 358 Jiangxi Copper and 700 Tencent are being watched closely for the rest of the week, but buy-signals are not available to me yet.) * = Previously held position.
Down-move list to be publicized at a later date and this post to be updated with technicals on each of these stocks tomorrow, after the close of trading.