What Actually Drives the Price of Oil

What Actually Drives the Price of Oil

SummarySupply is currently higher than demand by an estimated two million barrels per day according to the Energy Information Administration.Cross-market context is equally key. Watch the futures curve and options market.On April 17, 2016, key oil producing countries will be meeting in Qatar to “follow-up” on production freeze talks.Commodities are often associated with purely speculative investments. This is simply not the case. Just like a stock, commodities have fundamental drivers too.The price of oil has become increasingly more important since it began to tumble back in June of 2014. When the market started to trend with oil, interest in black gold surged even more. With renewed interest in oil, it’s essential to look at what the professionals consider when analyzing a trade.The oil market can be broken down into data points that derive from the price of oil, futures contracts, production, demand, and a variety of other factors. Looking into these factors will bring context to your oil investment.The Fundamentals of OilFundamental analysis normally starts with earnings or revenues. Traditional investable assets like real estate, bonds, and equities generate cash flow for investors—making valuation and fundamental work easier. Commodities like oil, on the other hand, don’t have cash flow—making them a pure price play. Accordingly, it’s essential to step back and observe the oil market from a macro point of view in order to grasp the current fundamental backdrop. This boils down to supply and demand dynamics.According to data from the Energy Information Administration (EIA), there is a tremendous daily glut of oil hitting the market. As the chart below displays, there are two million barrels per day right...
How the ECB is Actually Hurting Banks

How the ECB is Actually Hurting Banks

SummaryEuropean bank stocks have experienced an alarming decline. The credit default swap and options market confirm the aforementioned fear.Negative rates might have a short-term negative impact on European financials.The European Central Bank (ECB) will take action if financial conditions deteriorate further.European bank stocks have been getting slammed. Concealed by Chinese Yuan and Federal Reserve headlines, European financials have secretly been having a terrible year.  Poster child European banks like Deutsche Bank and Credit Suisse are down nearly 30% and 40% respectively in the last six months—starting this year worse off than 2008. Bank stocks seem to be acting as if we are destined for another 2008 financial crisis or late 2011 European debt crisis. Are equity prices implying another crisis or is the macroeconomic environment just that bad?Poor Banking EconomicsIt’s not a good time to be a bank in Europe. The European Central Bank (ECB) will likely vote to cut interest rates further into negative territory at their next meeting. According to an anonymous ECB governor in a recent Reuters interview, “doing nothing in March is very unlikely…[and] a deposit rate cut is fairly undisputed.”The ECB has three main interest rate levers it is able to adjust, each with a specific function. The Main Refinancing Operations (MRO) rate, which issues the majority of capital to banks, is currently at a mere five basis points (bps). The deposit rate, used for overnight facilities with the Eurosystem, is at negative 30 bps. Finally, the marginal lending rate, the price at which banks can lend overnight credit to institutions from the Eurosystem, sits at 0.30%. The ECB can move a number of...
Myth: America Will End Up Like Japan

Myth: America Will End Up Like Japan

SummaryInflation rates in Japan and the U.S. are currently below central bank goals. Japan, however, is significantly below target.Negative rates have been a reality (or close reality in real terms) for a few countries.The proposed 200 bps sales tax increase in Japan will be a key variable to watch for in the FX and JGB market.“Whatever it takes” is an aggressive mandate for monetary policy—nothing short of historic. Momentous action is called for, however, in the case of Japan. The Bank of Japan (BOJ) is attempting to rescue the country from its decade long economic slump. Accordingly, Japanese central bankers have passed some of the most aggressive policy measures ever seen.  Despite these actions, Japan is still plagued with subpar inflation growth and is far from its consumer price index goal. Across the Pacific, the U.S. seems to be in a similar boat.Much like the BOJ, the Federal Reserve (the Fed) is still shooting for an elusive inflation figure, despite historically loose monetary policy. Janet Yellen’s board is looking for Core Personal Consumption Expenditure (PCE) to hit 1.5%-1.7% in 2016 and 2% in the long run. In the latest data release, PCE index year-over-year (YoY) came in at 0.58%. The trend is favorable, with last month’s figure being 14 bps lower, but current levels are still far from the Fed’s 1.5%-1.7% 2016 target. Interestingly enough, PCE less food and energy (Core PCE) is a lot closer to the Fed’s target. Core PCE YoY reached 1.41% in the same release. This could lead investors to believe that food and energy is preventing the Fed from tightening more aggressively. The Fed’s...
Edge in Selling Options Part I: The Buy-Write

Edge in Selling Options Part I: The Buy-Write

Summary2015 was a great year for buy-writes; 597 bps of alpha was gained over the market due to elevated volatility and a stagnant market.Despite market myths, approximately 30%-35% of options expire worthless.Investors should be aware of the utility options provide for their own purposes or for when evaluating a portfolio manager.Alpha in Buy-WritesAlpha can be elusive. Many investors spend their careers chasing fads and attempting ill-fated trades to hopefully boost their performance. Finding these opportunities, historically, required a research team and other scarce trading resources. Now more than ever, these capabilities are freely available to investors through technology. Interest in extracting alpha via options has brought forth the rapid adoption of options as a risk management and return enhancement tool. As such, it’s essential to explore the benefits, risks, and opportunities options strategists provide.The options revolution began with the launch of electronic trading and the penny pilot program, where options spreads were allowed to be quoted in penny increments. As the cost of trading dropped, both commissions and bid/ask spread-wise, options exploded in popularity, showing consistent volume growth since their inception in 1973. From a macro point of view, options can provide a variety of opportunities. They can serve as an equity type investment vehicle, all the way to being utilized for pure speculation. Options can also be used as a strategic additional source of income when overlaid with stock, also known as the buy-write (most commonly, a long stock and short out-of-the-money call combination).Buy-writes combine the best of both stock selection strategies and time-decay oriented option selling. While similar in risk to a short put, buy-writes provide exposure...
So the Fed Raised Rates…Now What?

So the Fed Raised Rates…Now What?

Summary: Markets and managers are expecting two or three interest rate hikes in 2016, likely to occur on a meeting date with a press conference.The U.S. is leading the charge on higher rates, while China is slowing and the ECB is expected to actually cut rates further into negative territory.Default risk is indeed higher globally, likely due to the commodity bear market, but other measures of risk such as implied volatility show little signs of uncertainty.Janet Yellen is in a tight spot. Domestic economic indicators seem to be strong compared to the rest of the world, but a backdrop of diverging international economies seem to have gotten the better half of other central banks.Despite these concerns, the Fed stuck to its plan of raising interest rates in December to 0.25%, kicking off a new interest rate regime. Going forward, investors will need to look at the 2016 calendar for clues as to when the Fed will raise again. While there is nothing clear cut, plenty of speculation is in the market. The new age “briefcase indicator” seems to be FOMC meeting dates that have a press conference associated with them.  There are four opportunities for this in 2016. One of the largest asset managers in the world, Pacific Investment Management Company (PIMCO), foresees a base case scenario that includes three 25 basis point rate hikes, “consistent with where the central bank’s core leaders have indicated they are leaning for 2016, but greater than the two rate hikes that the bond market is priced for.”Markets are currently assigning a 14.1% chance, as of 01/13/2016, that PIMCO’s base case is correct...
What to Expect In the Final Quarter This Year

What to Expect In the Final Quarter This Year

We’re finally coming to a close for 2015, and the final quarter will be the conclusion to a year that’s been defined by uncertainty and uneven performances. Mixed economic data haven’t given investors a clear vision of what the future will look like, while other regions around the world have shared in a global economic slowdown that finally culminated in a collapse in the Chinese stock market last quarter.Volatility, which had remained relatively muted for most of the year, soared at the end of August through early October and could spike yet again before we see the end of the year. Of course the biggest news so far this year is the surprising move by the Fed to hold interest rates steady despite widespread belief by Wall Street that rates would be rising this year. While the Fed will meet again in December, based on lackluster data, it seems more likely that rates won’t see a lift until the end of the first quarter in 2016 at the very earliest.Unemployment is a bright spot in the economy at just 5.1% as of September’s numbers but is somewhat mitigated by stagnant wages and persistently low inflation. GDP growth for the first quarter was revised higher to 0.6% while growth for the second quarter came in slightly higher than originally expected at 3.9%. We’ll have to wait to see what the figures for the third quarter will be, but so far it seems to indicate that the economy is actually still in a growth stage but at a much slower rate than investors want.The Big PictureIt’s too soon to know what...