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IB Traders' Insight

Global market commentary from IBG traders and market participants.

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2014-04-22 14:59:42

Posted by
IB Securities Lending Desk
Contributor

Securities Lending

SLB Update: Largest Outstanding ETF Short Positions

These are the 15 largest outstanding ETF short positions among Interactive Brokers customers as of 04/17/14.

2014-04-22 14:02:12

Posted by
Singapore Exchange

Contributor

Futures

Path to becoming a major reserve currency - part 2

  • China’s share of the World’s FX market at 1.5% is disproportionately small relative to its share of World GDP and Trade. The 1% increase over three years from 2010’s 0.5% was due to the birth of CNH and the Dim Sum bond market.
  • Deepening both the Renminbi onshore (CNY) and offshore (CNH) financial markets coupled with reforms in the domestic capital markets are needed before China can fully liberalize and internationalize its currency.
  • Ultimately the timing and pace of the reforms will depend largely on China’s policy priorities. When China’s economy deepens and grows further, the need for a world class capital market will outweigh the benefits of a fixed exchange rate centered mercantilist policy.

As discussed in the path to becoming a major reserve currency - part 1 (click here), China’s Renminbi (CNY) was first unpegged from the US Dollar (USD) in 2005 and its relevant economic foundations. The second part of this focus shows a contrast, the gap between China’s economic fundamentals versus its share of the World’s capital and foreign exchange markets. Moreover there are sign posts that are likely to occur first before full liberalization of the currency can occur.

Current state of currency turnover

While China is the World’s second largest economy and provides one-fifth of world trade, the share of the CNY in the global currency market of USD 4.7 trillion is disproportionately small. From Chart 1 below, China’s share of the World’s FX turnover, has grown from 0.5% in 2007 to 1.5% in 2013 and is still dwarfed by the US share of 43.5%. While China is the second largest trading nation after the US, the bulk of its trade is settled in US dollars. China’s export revenue is paid in USD which has led to a massive accumulation of primarily USD-denominated FX reserves of USD 3.8 trillion. China has signaled intentions to diversify from the high USD concentration in its reserves but this could prove challenging without significantly impacting the mark to market valuation of its reserves.

Chart 1 – OTC foreign exchange turnover by currency

Source: Bank for International Settlements

The increase of China’s share of World’s FX turnover, by 1% from 2010 to 2013 was largely the result of establishing a market for the CNY on an off-shore basis from July 2010 through the CNH (Renminbi traded in offshore markets).

Chart 2 shows the increase of the CNH denominated bond market also known as the Dim Sum bond market from 2010. As noted in part 1 (click here) while China runs a current account surplus versus developed countries, it typically runs a current account deficit versus other emerging countries because of its huge importation of energy, materials and resources.

Chart 2 – Dim Sum bond market (CNH denominated bonds)

Source: Hong Kong Monetary Authority

The policy decision to make the CNY tradable off-shore led to the birth of the offshore Dim Sum bond market. This gave the economies that run trade surpluses versus China a means to buy Chinese assets with their Renminbi trade receivables. Due to a lack of full capital account convertibility, foreign investors have only been able to buy into onshore Chinese assets on a limited quota basis under the Qualified Foreign Institutional Investor scheme (QFII). Separately, the Dim Sum market which is only into its fourth year is still small in comparison to other global bond markets. The most recently revived plans to link together the Hong Kong Exchanges and Shanghai Exchange can help to address the shortfall of flows into China to some degree. Although the scheme is strictly meant for investors in Hong Kong and China and not open to other countries at this point.

For China to increase its share of global FX turnover and ultimately for the CNY to become a major reserve currency, China must open up its domestic capital markets to foreign investors. While Shanghai will play a key role in this, China is expected to continue further reform of its domestic capital markets to a point where market forces determine the pricing and allocation of capital. At the moment, the State and large state-owned financial institutions are primarily fulfilling the role.

Further, from a policy development perspective, market structures must also become more efficient and elegant so that the Peoples Bank of China (PBoC) can effectively execute monetary policy decisions aimed at balancing economic growth and inflation.

Interest rates market reform and currency internationalization

While the exact time line of CNY liberalization will be unknown, there are necessary foundations or signposts that investors can look out for before full liberalization can be achieved. Full liberalization can be defined as firstly, complete current account convertibility and secondly, complete capital account convertibility without restrictions to merchants, investors or other market participants.

Current account convertibility

In the context of China and many other emerging countries, current account convertibility is easier to achieve than convertibility with restrictions. In this context, trade flows of goods and services can occur without impediment as long as it is legitimately supported by trade documentation e.g. import and export papers, letters of credit. The flow of foreign exchange as a medium of transaction in this context is rarely an issue and hence, full current account convertibility is the easier of the two to achieve.

For full capital account convertibility, foreign traders and investors must be able to buy and sell financial assets without impediments. Typically, central banks and foreign exchange authorities will impose restrictions to prevent the free-flow of money across borders because of the potential for these flows i.e hot money to destabilize economies and markets. During the Asian Financial Crisis of 1997, the outflow of funds from some Southeast Asian economies caused interest rates to spike which subsequently helped contribute to economic recessions. Only a handful of countries in the world have deep enough financial markets that can weather the adverse impact of large amounts of funds freely flowing in and out of their markets.

In international finance, countries are restricted by the ‘Trilemma’ which is illustrated in the diagram below. Countries are able to choose between positions A, B or C. For a country that has free capital flow and a fixed exchange rate regime, it cannot have sovereignty over its monetary policy. Similarly for a country that has free capital flow and sovereignty over its monetary policy, it cannot have a fixed exchange rate. In China’s case, which is similar to position C, the lack of free capital flow, allows China to control its currency as well as set interest rate levels.

Chart 3 – The Trilemma

As China moves towards further liberalization of its currency which ultimately will bring it closer to points A or B, China has to choose between maintaining control over its currency or its monetary policy. Given the size of China’s economy at USD 9 trillion, the second largest in the World, policymakers could see much at stake in the prospect of giving up sovereignty over its monetary policy. China would likely gravitate towards point B.

What the theory means is that there is a basis for the CNY to delink itself further from the USD, and possibly reference its relative value to a basket of currencies of top trading partners. When this happens, the pin point precision that authorities currently can influence the CNY will cease and the CNY will behave more as a freely floating currency where global markets will set its value.

Authorities can of course intervene in the currency market, buying and selling occasionally to “set the tone” for the currency but it without a peg - policymakers cannot control the currency as it did before.

When China exerts control over its monetary policy, it first needs to further reform its domestic interest rates and fixed income markets. Currently, the People’s Bank of China (PBoC) still has control over various interest rates like deposit rates, lending rates and of course PBoC’s rates. In July 2013, the PBoC moved the floor of its lending rate to 4.2% with the benchmark rate at 6%. At the same time, the PBoC also sets the mid-rate for the CNY versus the USD.

As China moves towards having free capital flows and adopts interest rates as an anchor for its monetary policy, money markets, interest rates markets and bond markets which are all inextricably linked also need to harmonize and integrate closer. Piecemeal setting of individual rates will be a thing of the past as interest rates markets become more efficient. China’s monetary system will ultimately be one where the PBoC sets the policy rate similar to a Fed Funds Target Rate and the markets will then reflect that monetary policy decision in various segments of the yield curve. The CNY will then draw its international value base on supply and demand and relative interest rate differentials vis-à-vis other currencies.

SGX to introduce RMB futures in Q3 2014

Singapore Exchange (SGX) will introduce a new set of Asian currency futures to expand its current suite of foreign exchange (FX) futures in the third quarter of 2014, subject to regulatory approval. The new Asian FX suite includes currency futures contracts on Chinese Renminbi (RMB), Japanese yen and Thai baht follows closely after the initial launch of six FX futures contracts in November 2013, which have seen over US$1.3 billion in notional value traded in the five months since it began trading.

SGX’s introduction of Asian FX futures is in line with global G20 regulatory reforms where all standardised OTC derivative contracts should be traded on exchanges or electronic platforms, where appropriate, and cleared through central counterparts. The trading of FX derivatives on a regulated exchange platform will promote greater transparency, and better serve investment and risk management needs in the Asian time zone.

2014-04-22 13:11:25

Posted by
Caitlin Duffy
Equity Options Analyst
Contributor

Options

Casino stocks LVS, WYNN on the run ahead of earnings

Shares in Las Vegas Sands Corp. (Ticker: LVS) are up sharply today, gaining as much as 5.7% to touch $80.12 and the highest level since April 4th, mirroring gains in shares of resort casino operator Wynn Resorts Ltd. (Ticker: WYNN). The move in Wynn shares appears, at least in part, to follow a big increase in target price from analysts at CLSA who upped their target on the ‘buy’ rated stock to $350 from $250 a share. CLSA also has a ‘buy’ rating on Las Vegas Sands with a $100 price target according to a note from reporter, Janet Freund, on Bloomberg. Both companies are scheduled to report first-quarter earnings after the closing bell on Thursday.

A block of call options traded on LVS during the first hour of the session suggests one options market participant may be positioning for the price of the underlying to extend gains during the next couple of months. It looks like 5,535 of the 20Jun’14 calls were purchased at a premium of $1.70 each. The position makes money at expiration in June if shares in LVS rally 9.0% over the current price of $79.82 to exceed the effective breakeven point at $86.70. Shares in LVS earlier this year traded up to a six-year high of $88.28. Shares in WYNN for its part are currently trading up 5.5% on the session at $215.71.

2014-04-22 11:07:13

Posted by
Andrew Wilkinson
Chief Market Analyst
Interactive Brokers
Contributor

Stocks

Moyes sacking boosts Man Utd.

Shares in ailing English Premier League giant, Manchester United (Ticker: MANU) are trading at $18.00 and the highest price since the end of last season following news that the club fired manager David Moyes after a disappointing start to his tenure. Of course, following-on as the successor to Sir Alex Ferguson was always going to prove a Herculean task, and the first failure to qualify for European competition in 19-years for the world-famous Reds didn’t help Mr. Moyes cause. As ever, smart investors seemed to discount the end for Mr. Moyes well. Shares in the club traded on the New York Stock Exchange had been rallying for a week as poor results predicted the Glazer family, a disgruntled boardroom and players’ loss of confidence marked the end of his plight. Yet the loss of revenue from failure to secure a season in Europe next year and a weaker negotiating hand with key sponsors resulting from the team’s turn of fortune seem to have been quickly tossed aside by investors betting on happier times from the next candidate.

However, if you look closely at the volume of shares traded, you’ll notice just how little interest there is in the club amongst investors. A tight band of “supporters” bought into the IPO and the stock is largely illiquid. On Monday for example only 30,000 shares traded hands with a face value of around $525,000 – in-line, just about, with the weekly salary of Wayne Rooney. Highlighting the illiquid nature of the stock is the cost facing short sellers to borrow the stock in order to short it. The cost facing bearish investors for borrowing the stock is above 10% - a nice return for those bullish on the club who can lend out their shares. Even before the new full-time manager has been appointed, investors are predicting a significant revenue-generating reversal of fortunes. Judging by the ill-fated choice of David Moyes that might be a premature strategy with arguably deeper disappointment at stake should the trophy cabinet remain bare for a second season. Perhaps some United investors might look to profit by lending out their stock to those willing to put their faith in the Manchester United board.

Chart – Shares in the Red Devils trade on less volume than striker Wayne Rooney is paid each week!  

2014-04-22 10:45:15

Posted by
IB Securities Lending Desk
Contributor

Securities Lending

SLB Update: Most Difficult to Source ETF Locates

These are the 15 most difficult to source ETF locates during the week of 04/14/14 - 04/18/14.

2014-04-22 10:40:19

Posted by
IB Securities Lending Desk
Contributor

Securities Lending

SLB Update: Hardest Locates to Find per Sector

The following table shows the top five hardest locates to find per sector during the week of 04/14/14 - 04/18/14.

2014-04-22 10:36:24

Posted by
IB Securities Lending Desk
Contributor

Securities Lending

SLB Update: Most Difficult to Source Locates

These securities were the 15 most difficult to source locates during the week of 04/14/14 - 04/18/14.

* Indicates names that were initially rejected due to lack of locate availability.

2014-04-22 10:14:29

Posted by
Andrew Wilkinson
Chief Market Analyst
Interactive Brokers
Contributor

Options

Netflix implied volatility

In an update to our earlier note, we had thought our projection of a slide to 87% for implied volatility for options expiring Friday might be too aggressive. As it turns out, that slump in concern was way too conservative. The popping sound of options implied volatility coming out of the stock is far louder and has captured investors’ attention in the first 30-minutes of trading in options on Netflix. Thirty-day implied volatility on the stock has fallen by one-third to 39.5%, while for nearby options, implied volatility slid to ~55% from around 120% following the release of earnings after hours on Monday. Options volume of around 40,000 is significantly concentrated in the nearby expiration this Friday. Around two-thirds of that volume has been seen in calls (16k) and puts (13k) maturing in four days’ time at strikes ranging from 325.0 to 500.0. To give you a sense of the defensive nature taken by dealers ahead of earnings, call option premiums at the closest four in-the-money strikes are trading at lower prices on the day – unusual given the 6.6% jump in the price of shares in Neflix.   

Chart – Slide in 30-day implied volatility on Netflix post-earnings

2014-04-22 09:27:11

Posted by
Jamie Lissette
Trading Analyst
Hammerstone Group
Contributor

Stocks

Hammerstone recap

Monday was another good day for stocks as the S&P 500 extended its winning streak to a fifth consecutive session, marking the longest rally of the year.

The Macro

Monday was a light day in terms of macro data. The Chicago Fed activity index fell to 0.20 in March from 0.53 in February. The Conference Board leading indicators index rose to a seasonally adjusted annual rate of 0.8%, from 0.5% in the preceding month. Analysts had expected U.S. CB Leading Index to rise 0.7% last month.

Forum Comments

It’s interesting how the sentiment over at the Hammerstone Forum has improved over the last week along with the market rally. Earlier when the market was falling, many participants at the Hammerstone Forum had taken a highly cautious attitude, especially regarding the high-beta names. Now that the market has recovered, there is a lot of chat about buying names that took huge hits in the recent melt-down.

Participants at the Hammerstone Forum have viewed the earnings season with a positive sentiment thus far. On NFLX’s earnings, one of the participants noted that NFLX lost almost half of its value the last time it tried to change the pricing. Let’s see if it can fare better this time round.

Looking Forward

The only Fed speak this week is Ben Bernanke speaking to the Economic Club of Canada this morning at 11:45AM ET. While Bernanke may no longer be the Fed chair, his comments are always worth a listen. In terms of macro data, we get Existing Home Sales at 10:00 AM today. We also have New Home Sales tomorrow. The housing data this week will be interesting as housing is one area that has investors worried. Will we see the recovery in housing as we’ve seen in some other sectors?

Important earnings for tomorrow include AMGN, JNPR, T, VMW (tonight); BA, EMC, PG, YUM, AAPL, FB, QCOM, TXN. The tech and biotech earnings are very important for the growth vs. value battle, so we’ll definitely be watching them.

 

The Hammerstone Institutional Forum, a chat-based platform for traders, provides subscribers with up-to-the-minute breaking news headlines and instant analysis that drive the market. For more information please visit www.thehammerstone.com.

2014-04-22 09:24:59

Posted by
Andrew Wilkinson
Chief Market Analyst
Interactive Brokers
Contributor

Options

Netflix leaps in pre-market trading

An analyst price target has already been lifted on shares of Netflix (Ticker: NFLX) to $520 from $510 at Pacific Crest following earnings in which the online video service revealed greater growth in its subscriber base for the first quarter. Cantor Fitzgerald has shifted from “hold” to “buy" while Raymond James used the content of the earnings release to tag the stock’s predicted outlook with “outperform” rather than “market perform”. Shares closed around $348 before the release with options implying an approximate $42 move either up or down as a result of earnings.

In pre-market trading we have captured the changing sentiment amongst investors along with our projection of lower implied volatility surrounding the stock when trading resumes. Typically, option markets tend to calm especially when the share price heads higher rather than lower when uncertainty is reduced in the form of better-than-expected earnings. In the following chart we are showing the Probability Distribution implied by options expiring on Friday. Implied volatility was sky-high at this expiration – 122% compared to around 60% on 30-day options. The blue curve represents the pre-earnings prediction as shares settled on Monday, while the red curve displays the likely trajectory at pre-market of share prices coupled with a slide in implied volatility. Of course, volatility at Friday’s expiration might move by more or less than we are showing in the chart. The updated bell curve is taller than the pre-earnings distribution on account of the assumed reduction in options implied volatility as, by definition, certainty increases.   

Chart – Netflix Probability Distribution before and after earnings

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