New Data, Even Stronger Relationships

It was another week and another very small gain in an option. And even that was tough to come by as the very recent trend in oil and even in oil stocks has been mostly up. A year or two ago we would have sat out the uptrend and waited for a reversal. But that was then. Today, as we’ve been arguing, the world’s economy is in transition as leadership passes to China. While we continue to include China-based statistics in our indicators, we think we still have a little more work to do on them.

Small as the latest option gain was, our winning percentage on options is now over 80 percent, and our winning percentage on the underlying ETF/commodity is 90 percent. Both percentages are well into the “six sigma” area.

Perhaps even more encouraging is that when we look at some of our indicators, even including oil stocks, we find that when we add in the data from the past year and a half – data that was not available when we were developing the indicators –the relationships actually grow even stronger, not weaker. This means that some of the indicators work better on new data than on the data to which they originally were fitted.

This is strong evidence that we have been accurately picking up on the changes in the world’s economy. Still, highly leveraged trading is a pursuit in which losses can hurt a lot more than winners can help. Remember, if you start with $1000, a 50 percent loss followed by a 50 percent gain leaves you down by 25 percent. And as we have stressed, at times of inflection – periods, like today, when the world is changing – relationships among economic variables also change.

Seth Klarman, one of the all-time great hedge fund managers, recently commented that the proliferation of quantitative trading is a recipe for disaster as almost all quants follow the same formulae. So when the relationships underlying those formulae change, the result could be a massive market decline, on a par with what we saw in 2008. While in this business you never can make promises, we are very determined to be on the right side of the next very big move. So far the only price we are paying as we add and subtract variables is a little less trading than we would like and too many gains that are smaller than we’d like.

To increase the number of trades we make, one change you may see in the very near future could be options on stocks within an index. Thus instead of buying a put on the Select Sector SPDR Energy (XLE), we might buy a put on one of the weaker stocks in the index, such as a fracker outside the Permian Basin – Continental Resources (NYSE: CLR), for example. In sum, we’re saying that despite our six-sigma performance, we are keenly aware that you expect and deserve more, and we will do our best to deliver.

For the record, out of all the indicators we follow, our oil stock indicator is the only one that is clearly outside the neutral zone. It is bearish, so don’t be surprised, especially given the evidence that the indicator is still on target, to see another negative oil-related trade.


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