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THE KNOWN UNKNOWN Markets have become reacquainted with volatility over the last 7 months and with a host of omnipresent macroeconomic factors still unresolved, this seems like a good time to discuss tail risk. Throughout my career, I've found that a lot of institutional asset managers rely on Value-at-Risk (VaR) as a risk management tool.  Unfortunately, this practice is completely inadequate as VaR cannot protect against against outsized, downside losses - also known as tail risk -... probably because it was never intended to. VaR is merely an interval threshold measurement given an assumed degree of confidence.  So if we assume a 95% confidence interval for daily, monthly or annual returns, VaR will tell us the single point at which we would expect 5% of our returns to fall below.  Conversely, VaR represents the point where you expect returns to be greater than 95% of the time. VaR does not, however, give the user any information about the shape of a given return distr...

"Give me a lever long enough and I'll move the world." -Archimedes Options are a very popular tool for the purposes of hedging and speculating because of their exponential return profile... relatively small cash outlays have the potential of delivering very large profits. Above, we see a chart of the April 22nd ATM put option on the SPY (currently trading just above $203).  The contract is priced at $2.85 and in the case of an immediate move in the price of the ETF, the price of the option will follow the blue curve... exponentially higher in the case of lower SPY prices and lower at a decreasing velocity in the case of higher a higher SPY price.  At 4pm EST on April 22nd, the price of the contract will lie directly on the orange line as the time value associated with the contract will have completely decayed. The line and curve in the chart above represent the leverage benefits of options investing.  If, at expiration, the price of the SPY has fallen to $190, the value o...

ANOVA In statistics, the analysis of variance - more commonly referred to as an ANOVA - tests the relationship of multiple sets of means to determine if their respective populations are significantly different from one another and, therefore, independent. Means are a ubiquitous analytical tool.  For the purposes of quantitative trading, changes in means and their delineation of interval trends are commonly cited factors when trying to determine future price paths; these are more commonly referred to as moving averages.  When interval moving averages are observed on a relative basis, we can conduct a 'technical analysis of variance.' In plain English, we can easily observe the 20 day moving average of a stock to get a basic understanding of its recent direction and momentum.  We can similarly observe the 50 day moving average to understand the stock's longer term direction and momentum.   Additionally, we can measure the dispersion of the stock's price to these histor...

Here's a quick review of names that are moving in a market that seems to be recovering from a couple bouts of conspicuous price action. GO LONG On the long side, a few names are notable because of strength relative to their overall sector's weakness - especially in technology and healthcare (as I've documented to death on this blog). Cisco Systems - CSCO Intuitive Surgical - ISRG Goodyear Tire & Rubber - GT United Airlines - UAL BREAKING DOWN On the short side, price actions are far more congruous . Incyte - INCY Celgene - CELG Biogen - BIIB Ecolab - ECL  

THE STARTING ROTATION Spring is upon us and, thankfully, baseball is just around the corner.  Major League Baseball clubs are currently preparing for the season at their respective spring training facilities in Florida and Arizona.  As always, one of the biggest questions each team faces is what their starting pitching rotation will look like come opening day.  Pitching comes at a premium in baseball; name another profession where you work once or twice a week and can make $30 million a year.  Like the saying goes, "it's good work if you can get it."  Success in baseball ultimately begins with starting pitching. The market has relied on its aces - technology and healthcare stocks - to propel its most recent bull run.  But what happens when your starters run out of gas?  If you're Grady Little, you stick with them (forgive the dated reference but it still brings a smile to my face).  Recently, we have begun to see signs of sector rotation as long d...

The price of oil has recently experienced a brief respite from its almost 2 year long rout.  Market pundits have (falsely, I believe) correlated this pause with the recent gains in the broader indices.  However, technical trading patterns would suggest that bears may be returning to feast on the old-world energy source. To better understand the logic, let's look at the chart of USO (Oil's primary ETF): First, let's breakdown what's currently happening:  The price of USO has reverted back up to its 50-day moving average which is acting as a resistance level. It failed to break through the resistance and has moved lower... albeit only slightly lower. When prices move between converging moving averages, like we're seeing here, they tend to consolidate with each average acting as support and resistance... when prices eventually move outside of the averages, they will tend to breakout As traders looking to exploit option leverage, we always want to be in positions that a...