Stocks and Trading Thread - Channeling your inner Mono

[alfred russel]

There are a couple of problems with the "let investors take risk, they're diversified" logic. 

First, financial distress incurs costs that are a waste.  Secondly, if your company can live or die based on some random factor outside of its control, you're either going to be less attractive to potential employees, or you'll have to pay them more.  Lastly, if your company's business is not hedged, its income will fluctuate wildly.  That's not very tax efficient.

I don't know about the tax efficiency part, but that is basically what I was arguing a few days ago.

Obviously there is a lot of truth to that, but there is also truth to the fact that businesses with solid balance sheets are hedging against currency risks so they can present more consistent returns to analysts. To that extent, I think there is truth to what I am posting today. 

[alfred russel]

I don't see a problem here at all.  The point of a hedge is to insulate your business against outside influences, because bankruptcy has real costs that amount to waste.  If fuel prices rise, then the value of core business goes down, but you get a payoff from the futures.  If fuel prices fall, then you lose on the futures, but at least you have a profitable core business.  That's why it's a hedge:  it evens out the outcomes if you treat the hedge and hedged item as one unit. 

What probably happened is that Delta gambled and lost.  I also doubt that Southwest would've been bankrupt if fuel prices decreased, as long as their hedge was properly constructed.  If your hedge can bankrupt you, then it's not a hedge anymore, it's speculation.  Obviously airline companies shouldn't speculate as if they're Goldman Sachs, but not hedging their exposure to fuel prices in some way is dumb.

What I think happened is that Delta needed to cut costs, and hedging is very expensive. There were academics making the case I am making, and so they decided to stop hedging.

It has been documented as a classic case of management shortsightedness. But it doesn't change the dynamic. Roughly speaking, basic futures lock in the current fuel price. If everyone is using those futures except Delta, then as most airlines are paying the historic fuel price, in the short term Delta is the only one exposed to fluctuation. If the price goes down, they can undercut Southwest. If the price goes up, they will be undercut by Southwest.

Delta could expect to come out ahead for two reasons because it didn't have to pay for the expensive hedges. But in the larger sense, are fuel hedges really effective? Yes, if fuel prices go up that will increase costs, and thus prices, and thus the demand to fly. But fuel costs are linked to the economy, which is also linked to demand to fly.

These days, both Delta and Southwest have fuel hedges, but strategies differ, and a diversity of financial products mean they can differ a lot. Hence airlines are in part competing based on their ability to gauge futures markets for fuel rather than the service they provide. Delta buying a refinery probably doesn't seem crazy to Delta executives because fuel speculation is effectively a core part of their business.

[DGuller]

What I think happened is that Delta needed to cut costs, and hedging is very expensive. There were academics making the case I am making, and so they decided to stop hedging.

One caveat to what I was saying would be that if Delta were already on the ropes, it should not have hedged.  Once you're in trouble, you may as well let it ride, and have bondholders take it on the chin if fortune doesn't go your way.  Once you're likely to go bankrupt, you don't really care whether you wind up being $1 in the red or $1 trillion.

[alfred russel]

What I think happened is that Delta needed to cut costs, and hedging is very expensive. There were academics making the case I am making, and so they decided to stop hedging.

One caveat to what I was saying would be that if Delta were already on the ropes, it should not have hedged.  Once you're in trouble, you may as well let it ride, and have bondholders take it on the chin if fortune doesn't go your way.  Once you're likely to go bankrupt, you don't really care whether you wind up being $1 in the red or $1 trillion.

So I guess I was thoroughly unconvincing. Bummer--I thought this was one argument I could change someone's mind.

Would you at least go with another caveat that if you are simply one of many airlines struggling to break even in your hellhole of an industry, then it could make sense to stop hedging in the knowledge if things go your way you will get massive returns, and if not, you will only lose the few crappy gains you can expect in the industry as you explode.

[DGuller]

What I think happened is that Delta needed to cut costs, and hedging is very expensive. There were academics making the case I am making, and so they decided to stop hedging.

One caveat to what I was saying would be that if Delta were already on the ropes, it should not have hedged.  Once you're in trouble, you may as well let it ride, and have bondholders take it on the chin if fortune doesn't go your way.  Once you're likely to go bankrupt, you don't really care whether you wind up being $1 in the red or $1 trillion.

So I guess I was thoroughly unconvincing. Bummer--I thought this was one argument I could change someone's mind.

Would you at least go with another caveat that if you are simply one of many airlines struggling to break even in your hellhole of an industry, then it could make sense to stop hedging in the knowledge if things go your way you will get massive returns, and if not, you will only lose the few crappy gains you can expect in the industry as you explode.

That's a continuation of a previous argument.  If the average returns are terrible, let it ride.  If you're playing roulette in a casino with borrowed money, hedging by betting on all 36 numbers is not a very smart strategy.

[MadImmortalMan]

For the hell of it:

Bear call spread on SPY weeklies--133/134 net credit .17 qty 50. Total profit if spy does not hit 134 before tomorrow is over: $900.

[alfred russel]

I talked about it a few months ago, but today I decided to take the plunge and short US treasury bonds.

I tried to short the ETF EDV, but it wasn't available. 

I moved on to the ETF TLT, but I didn't get it executed before close.

So hopefully something crazy won't happen before open tomorrow. If anyone has a better treasury government bond ETF to short, let me know. I liked EDV because it had long term bonds. TLT is a bit shorter (16 years average duration--wanted 20+), which is bad. Maybe I'll be able to short EDV tomorrow.

[Admiral Yi]

Bad move IMO.  Not the slightest sign of inflation, no pressure on the Fed to tighten.

[alfred russel]

Bad move IMO.  Not the slightest sign of inflation, no pressure on the Fed to tighten.

The 30 year rate is 2.80%.

This isn't a 3 month play, this is looking at it thinking over the medium term rates are probably going to be significantly higher.

[Admiral Yi]

The 30 year rate is 2.80%.

This isn't a 3 month play, this is looking at it thinking over the medium term rates are probably going to be significantly higher.

You're going to sit on a short for 2 to 5 years?

[alfred russel]

The 30 year rate is 2.80%.

This isn't a 3 month play, this is looking at it thinking over the medium term rates are probably going to be significantly higher.

You're going to sit on a short for 2 to 5 years?

Why not? I've basically not been buying anything for a couple years. I have a bunch of cash not doing anything, and interest rates are basically zero so it just getting inflationed away (even if inflation is low, it isn't zero).

[Admiral Yi]

Why not? I've basically not been buying anything for a couple years. I have a bunch of cash not doing anything, and interest rates are basically zero so it just getting inflationed away (even if inflation is low, it isn't zero).

Please tell me what your play is, so that you don't get eaten alive by premiums.  Did you buy in to a bond short fund?

[alfred russel]

Please tell me what your play is, so that you don't get eaten alive by premiums. 

How are you going to stop that, are you going to pay my premiums for me? 

The bond short funds are for shorter term plays--they tend to have high fees and don't correlate well with the market over the long term. It is also less transparent exactly what they are doing.

I'm trying to short a long term US government bond index ETF. The fees I will pay are the trading commission (same as a stock trade) plus I will have to pay the dividends for as long as I hold the short (at less than 3% a year that isn't bad--this is what typically makes shorting bonds a loser). As long as I keep the account adequately funded I won't have to pay the brokerage interest (that shouldn't be hard since I have a bunch of cash doing nothing right now).

[Admiral Yi]

How are you going to stop that, are you going to pay my premiums for me? 

Bah.

[alfred russel]

How are you going to stop that, are you going to pay my premiums for me? 

Bah.

Seriously, if you have a better idea how to play this, let me know.