I'm thinking the same thing. Here is another article supporting your thesis:

http://online.barrons.com/article/SB123094029415750267.html?mod=b_hps_9_0001_b_this_ weeks_magazine_home_top&page=sp

The only thing that gives me pause is the lack of performance I saw in the oil & gas ultra-short funds as oil came down. Take a look at DUG for example. I would like a way to short the treasuries directly to avoid the fund's leverage reducing my return.

The following article looks at the problem:

ETF Math Lesson: Leverage Can Produce Unexpected Returns
By TOM LAURICELLA

Exchange-traded funds that use leverage are proof positive why investors need to read the fine print.

Many of these funds promise to deliver twice the return of an underlying stock or bond index -- or move twice as much in the opposite direction. So with the Standard & Poor's 500-stock index down 38.5% in 2008, a double-leveraged fund designed to profit when the S&P 500 falls would be up 77%, right?

Wrong. The UltraSHORT S&P500 ProShares rose 61%. Even more confusing, the ProShares fund designed to return twice the opposite of the Dow Jones U.S. Real Estate Index was down 50% for 2008, while the index was also down, by 43%.

The issue is that these funds are designed to double the index's return -- or double the inverse of that return -- on a daily basis. The compounding of those daily moves can result in longer-term returns that have a very different relationship to the longer-term returns of the underlying index.

For example, take a double-leveraged fund with a net asset value of $100. It tracks an index that starts at 100 and that goes up 5% one day and then falls 10% the next day. Over that two-day period, the index falls 5.5% (climbing to 105, and then falling to 94.5). While an investor might expect the fund to fall by twice as much, or 11%, over that two-day period, it actually falls further -- 12%.

Here's why: On the first day, doubling the index's 5% gain pushes the fund's NAV to $110. Then, the next day, when the index falls 10%, the fund NAV drops 20%, to $88.

The effect of compounding results in greater distortions when there are big up and down swings in the market. That's the reason the real-estate index and its double-inverse ETF were both down over the course of last year.

For the most part, these funds are used by short-term traders. But they're gaining traction among individual investors who use them as a hedge in a portfolio. That's where these distortions cause real trouble.

Take an investor who on Oct. 10 wanted to offset a $100,000 investment in an S&P 500 index fund by putting $50,000 in the UltraSHORT S&P500 ProShares. Two months later, despite big back and forth swings, the S&P 500 was pretty much unchanged. But that ETF was actually down 24% in that time frame, leaving the investor with a $12,000 loss.

To ProShares' credit, warnings about the disparity between daily and long-term returns are spelled out in the materials for the funds and on the firm's Web site.

"We try to get the concept out to people," says Michael Sapir, chief executive of ProShares. "It's just a feature of this kind of investing."

http://online.wsj.com/article/SB123111094917552317.html

--

ideas?

I think I understand the mechanism, Wayne. I just don`t understand why you say you shorted treasury bills. You bought them and are betting that their rate will rise. Would shorting not be based on the opposite (betting that their rate will decrease) ?

Okay got it. You bought an instrument that is based on the opposite of the treasury bills, hence the shorting. Now, explain to me the advantage versus buying treasury bills directly, if you know their rate will go up? Well, maybe treasury bills cannot be bought so easily, is that the answer?

Jmo....
 

I don't know any one that doesn't think that Treasuries will fall in value (increase in yield). Barron's had an article as well as the Wall Street Journal (several), Forbes, the Financial Times....

The way to make money on any short is to get the timing right. Your theory has the price of the bonds going up in 2009. I am not so sure that it will happen that way. I have a sizeable position in T-Bills and don't see me moving away any time soon. There is an old saying that I learned along time ago when I was a money manager "Never short a dull market". Treasuries are as dull as they can be right now.

I don't think the short will work until the economy turns around. I don't see that in 2009.

If you are hedging you take away much of the upside if you are correct. I also think it means you are less than positive in your theories.

A short requires the use of margin. You are also using margin with a loan on your house. The problem with margin is a guy can run out of liquidity before his trade becomes profitable (just ask those hedge funds that lost big last year).

I think there is a time to take risk and a time to be conservative ("Don't fight the tape"). I am staying conservative until the tape tells me otherwise.

I have never had a loan. I did own two businesses that didn't require a lot of capital (business loans are good, if used properly). I remember when the financial pundits would always argue that a guy should keep personal loans with low rates (mortgage, student, low rate car loans) and invest in the market because the market always went up 10%/year. They said it is a sure way to wealth!

That didn't work so well last year.

My suggestion on what etf to buy for a rising interst rate/lower price for the ten year note is TBT.

Note: The fed said yesterday that they will be looking at buying Treasuries if long rates go up more than they want them to so watch out for when they do buy.



http://finance.yahoo.com/q/bc?s=TBT&t=1y

That is true. The Fed will see that rates stay low so the housing market will start healing itself. Otherwise, home prices will continue their free fall which will further weaken the banks which will further weaken the economy. And the Fed can write a big check to be sure rates stay low.

When the economy starts to heal, and the Fed decides to stop keeping rates artificially low; a well timed short on the long bond would be profitable.

There you go predicting the sunrise again, and this time you have bet that the sun will rise at midnight (Pacific time).

FOMC Transcript:

It's you vs. the Fed with this trade.

Is there a way to short CA Municipal Bonds? I'm betting those will default.

Of course, probably everyone else is thinking the same thing so this would probably have been priced in by now too...

Wayne, did you buy TBT or PST?

Your last link, Prudent Bear, I've been in that one for around a year, thankfully.

www.updown.com

We all need to join, and have a competition.

I learn more and more on the market every day. Thanks Wayne.

This is a NO BRAINER folks....Panic has ensued and people have moved into T Bills for safety and when that panic subsides interest rates will climb back to more normal levels...DUH!!!!

I will say it again, The Chinese and other furiners have the veto power over US spending. All they have to do is refuse to buy our debt. It might very well be redux of the late 70's and early 80's with 16% interest rates. That would spell the death knell for ANY economic recovery. THAT WILL STOP THE US GOVT FROM SPENDING.

The rational for the USD climbing in value and the Treasury interest rates sinking even into negative return territiory is that those furiners are more afraid of their own currency and economys than that of the good ole USA...

So is this an interest rate bubble in light of the financial meltdown or was this a rational move as the financial system DID collapse? You take your choich. Interest rates will climb from here as money will flow into other investment classes once the fear and panic subsides...that will happen once people get a clear idea of which way things are moving.

I gues the end of the world didin't happen after all...at least not yet.

If you really wnat to watch the wya things are moving..as a response to US policies...Watch 3 things

1. Price of Gold..always a hedge against bad times since the world began. Also reflects the true value of the USD. If GOld should climb above the $1000 mark to $1500 and continue to climb strongly...watch out

2. Interest Rates...reflects world confidence in the American economy, if furiners stop buying US Debt, they don't like nor think the US is doing the right thing. So if interest rates start to climb steadily because of poor participation in the Treasury auctions watch out

3. The exchange rate on the USD....the USD is just about the only currency of scale that has credibility, at least since WW2. If their is a mass exodus from the USD and its value starts to fall sharpely watch out

4. As a collorary..If there are moves to supplplant the USD as the exchange currency for oil..ohhh boy that is time to batten down the hatches.

The key here is to watch all 3 of the above indices, and if all three are starting to move in conjunction in the direction I have suggested then the jig is up.

None of the above will ever happen. No matter how bad our economy gets all the others will always be worse. America has the greatest capacity to create hence our strength. China may build it but they cannot create it. No other country can either. What ever happened to the Beta format?

Jebus, you guys are spooking the hell out of me. Wife and I just applied for a mortgage. $506k on the primary @ 5% + HELOC, variable, no year to year limit on % increases, $350k. We're bringing almost 30% to the deal, and they still won't go over $506k on the primary. It would take us 5-6 years to pay off the HELOC.

It would take a hell of a lot longer if interest rates were at 14% :(

Dump the HELOC and get a fixed.

Well a fixed over $506k is a jumbo, and like hell I'm paying 7-8%. That statement might seem foolish years from now when the rates are 12%, but thats how I feel. I have a 5% ARM good for another 4.5 years. Jeez, we should just stay where we are and refi.......:(

Wayne
Curious as to what % of your portifolio you converted to this stradegy.
Jim

This is why we have quite a few I bonds...Way ahead of you, Wayne. Bought the first ones four years ago...current yield around 6%. BTW, I don't consider them a good buy today.

I'm quite a bit older than you, so we're more heavily into bonds than equities...lucky for us, considering the recent downturn.

Your an asute investor. You do your numbers and come up with solid conclusions.

Why buy the ETF? Why not use options on the ETF?

I'd say dump the loans and be mortgage free.

If 2008 didn't show but one thing, it is that debt can bury you. I much prefer to loan money to other people than to be the guy paying interest. A guy with no debt can take more risk in the financial markets than a guy that owes money on a jumbo loan.

I paid cash for my house 22 years ago. I loan 40% of my money to American taxpayers (short term U.S. Treasuries and U.S. TIP bonds) and have the remaining 60% of the portfolio in blue chip (i.g., good balance sheet) dividend paying stocks.

There will be a day soon when I'll take more risk. In the meantime, I refuse to try to catch a falling knife, and I do not plan to be the pig that gets slaughtered.

Most people don’t have the cash laying around to pay for the house, in fact very very few do so that’s moot point. As far as 60% in blue chips, well blue chips got smoked in 2008. I would say that if you can get cheap money in fixed mortgage you’re better off taking the money now and working to beat the fixed rate you’re paying over time and its like not paying interest at all.

Dividends are nice except when the stocks fall by a much greater amount then the div paid.


Credit and debt are not bad things, it depends on what kind and how you use it.

"Dividend-paying stocks, seen as a safer bet as the broader market deteriorates, have become a trickier play as some companies cut or eliminate dividends to shore up balance sheets.

At least 10 major companies have taken actions against their dividends this quarter as the crumbling economy puts pressure on earnings.
Oliver P. Quilla for CNBC.com"
NYSE Traders


http://www.cnbc.com/id/28996008
--------------------------------------------------------------------------------

Interesting discussion. Of course if you have any variable rate debt, I'd say pay that off first before the rate takes off.

The case to be made for a variable rate note is if you're 100% sure you're selling before its going to change.

I'd then say that they spend beyond their means. The house I now own isn't my first one. I bought a small house (sold it for a profit), and then bought a bigger house (ditto), and then bought the house that I currently live in.

I'd guess that I've saved $500,000 in interest. Mortgage interest isn't totally deductible after you start making decent income.

What investment other than Treasuries beat mortgage interest rates last year? I know the S&P500 was down 37%, commodities got killed, and even corporate bonds were savaged. Once you lose this much in one year, it is very difficult to get back the money that could have paid off a home loan.

That is true, but not one stock that own I has cut the dividend rate. I am still getting income taxed at 15%, and I can wait until the stock comes back because I have no debt.

That is true. A business owner can make money if he borrows money to buy a piece of equipment that earns a good ROR.

Nonetheless, 2008 taught us that most consumers do not have the intelligence to properly use debt. It also taught us that most banks do not have the intelligence to loan money to people that can pay it back.

After all, we would not be in this severe recession if this country had used debt properly.

Options could give more "leverage" -- and potentially higher returns -- but that leverage can work both ways and one can lose more money faster too. (The TBT and PST are double short ETFs, so they are giving leverage already.)

With the volatility as high as it's been, the premiums for options can be quite high -- but that can create good opportunities for those holding the ETFs, or stock, (like Wayne) to write covered calls against the positions and make some good percentage returns.

One could work a complex options position, but for the more average investor, keeping the trades "simpler" is sometimes best.

I like Wayne's short Treasury position (much better than getting long Macy's and GM!); now we just need to get him to buy some gold and silver (and palladium too).

I am not talking about shorting any options so your risk is limited to only what you paid to leverage your long position synthetically in the ETF. The only time you get into a situation with options where you have unlimited risk is in shorting options.
Long stock, or in this case the ETF plus short call ( ie. Covered calls) is the synthetic equivalent of naked short puts and that’s where you have significant risk.
As far as a “complex” options position I would hardly call some sort of vertical call spread really complex and you could achieve similar long deltas.

Good thread going!

I didn't know there was a market for shorting options.

I thought a call option buyer paid a premium to the option writer. The buyer is betting that the stock (or commodity) was going to increase in value.

I also thought that a put option buyer paid a premium to buy a put on a stock (or commodity) from the writer. The buyer is betting the security will fall in value.

An option also involves leverage. A simple purchase of a 40-contract is a bet on 4,000 shares of stock. The writer can be covered if they own the shares or naked if they don't.

I've know a very few traders that make money by using straddles and spreads. I have never meet a person that had a vocation that wasn't trading options that ever made any money over a long period of time. After all, that person is competing in a zero sum game (for every winner there is a loser) with a professional that sits in front of a Bloomberg all day. That professional may be a quant expert with a degree from MIT. He probably has 12 computers calculating up to date information, and a staff with degrees from Wharton.

I also remember several years ago when a few mutual funds blew up trading options. I don't now know of a single mutual fund that does anything but use options occasionally (buying out-of-the-money protective puts on held stock positions). Anyone know of a pure option mutual fund?

The derivative trading business is profitable for the exchanges. I recently went long on NDAQ and NYX (they were down ~70% from their highs).

I'm interested in the exchanges because think OTC biz will be forced onto exhanges. Not sure how much trading volume that actually is, though. And not sure if CDS biz will be constrained. Any views?

Most mutual funds cannot use options as written in their own mission statement.
You can always short options, anytime you buy a call or a put, someone had to sell it to you and therefore they are short that option.

Options are not necessarily a zero sum game, here is an example. You buy a call option on XYZ from me. XYZ then goes up in price and your call option goes up in price. You sell the call option before expiration for a profit. You don’t have to sell it to me you sell it to the market. I am still short that call and xyz now falls in price and thus the call falls in price and then I cover it for a profit. Or, you buy the call from me and I am now short the call but I hedge with either another call or the underlying stock.

Spreads are simple ways to limit risk and many many many retial investors / traders use them to consistently add gains to their portfolio. Straddles are a lot different and I would say that if you simple buy a straddle or short a straddle and then sit and wait its not going to be easy to make money. Straddles are implied volatility plays (vega plays) they’re not buy or short and hold plays. Long straddles give you the ability to trade the net positive gamma buy buying and selling the underlying when it moves. Shorting a straddle also needs to be hedged accordingly when the underlying moves.

As far as the markets go, just about all the options markets are electronic these days which means the trades are just setting their pricing parameters and their computer is spitting out the bid and offer. They don’t really care where the underlying stock goes since most firms are running what’s called a dispersion portfolio where they trade the implied volatility in the options vs. options on other stocks in that sector or index options.

Remind me again how this isn't just a glorified form of gambling?

You talking about the global capital markets in general?

I understand that most mutual funds do not allow options.

But some do allow option trading within their individual Prospective Agreements. I am just trying to determine exactly how many investors in mutual funds (and individual accounts) have enjoyed superior returns by investing in options?

We know the big players. They usually graduated from the Quantitative Programs (the lady in Paris, France is well known).

Please inform us to your option trading results over a number of years? Most importantly, we would like an exact summary of your profitable trades going forward.

I do not doubt for one second that you are very wealthy due to your trading of options. I'd just like a few forward positions that can help the rest of us to be profitable.

First of all I don’t waste time discussing money, wealth, returns or material goods on line when we can’t see each other’s accounts. I was being civil, you’ve chosen to not to be. Show me where I implied any sort of great wealth on my part?

As far as options go, I spent 20 years as a professional options trader, having had seats on three different exchanges and been an off floor member of one other.

There is no way to determine how many people have increased their own returns via options just the same way there is no way to determine how many people have lost money.
You may continue with your sarcasm and smuggery.

You have already stated you don’t believe people should buy homes with mortgages and I am not surprised to find this sort of attitude from you regarding options and the capital markets in general.

For the record, I am not a quant, I don’t have an advanced degree in mathematics nor a Ivy League education. You don’t always need those lessons to understand the principles of options.

In my experience, very few equity mutual funds will actively trade options. They will sometimes lend their shares to shorts, and sometimes to sell covered calls against them. But most equity mutual fund managers do not have the mandate or the experience/skills/systems for options trading. Same for most managers of institutional equity portfolios.

I think it is a shame. Being able to hedge an equity position, or simply market exposure, at certain times would be darned useful for us. But it has to do with inertia as well as client mandates.

I've read the double inverse is only suitable as a short-term vehicle and not for long-term holding. I still ache from getting slaughtered in short-term homebuilder put options, so I'm not jumping in this game. I was right on the direction, but wrong in timing.

I believe your theory is correct, and you only need patience.

jyl, wouldn't trading CDS on an exchange create more problems with regards to market valuation? The swaps are probably being valued optimistically now, and I can't see how exchange trading would support those lofty opinions.

Wayne thought you might like to read this article:


http://www.bloomberg.com/apps/news?pid=20601103&sid=aryE4wUPBu9c&refer=news#

Fed Lacks Consensus on Treasuries as Yields Rise (Update1)



By Scott Lanman and Craig Torres

Feb. 9 (Bloomberg) -- Federal Reserve officials have failed to resolve an internal debate over whether to purchase long-term Treasuries, even as rising yields on the securities threaten to undermine the central bank’s objective of cutting borrowing costs for consumers and businesses.

Policy makers are instead focusing on a program to purchase $200 billion in consumer and small-business loans and on a plan to buy $600 billion in home-finance debt, according to people familiar with the deliberations.

Forgoing purchases of Treasuries may exacerbate a jump in borrowing costs for the government as federal debt managers seek to finance an unprecedented budget deficit. Benchmark 10-year note yields this week exceeded their level of Dec. 1, when Fed Chairman Ben S. Bernanke first talked about the option. That’s raised other borrowing costs, potentially delaying a recovery.

“The Fed will get a lot more bang for its buck by buying mortgages than buying Treasuries,” said John Ryding, founder and chief economist of RDQ Economics LLC in New York and a former Fed economist. “We were kind of a little surprised when the Fed wanted to go down this route” in comments starting in December, Ryding said.

Fed officials are seeking other ways to use monetary policy to ease credit after cutting the benchmark interest rate almost to zero, completing more than 5 percentage points of reductions since September 2007.

FOMC Meetings

The debate over buying Treasuries has now continued for two meetings of the Federal Open Market Committee. The potential acquisition of government debt to help finance a bank rescue doesn’t appear in the minutes of the December meeting.

The FOMC’s post-meeting statement on Jan. 28 signaled that not all participants are convinced. The panel “is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets,” the statement said.

That’s still a harder line than on Dec. 16, when policy makers said they were “evaluating the potential benefits of purchasing longer-term Treasury securities.” Bernanke said in a Jan. 13 speech that the FOMC will focus on the “potential” of the purchases “to improve conditions in private credit markets, such as mortgage markets.”

Fed Split

Richmond Fed President Jeffrey Lacker dissented from the Jan. 28 decision, highlighting a split between the Board of Governors and some Fed presidents on how to stem the credit crisis and revive economic growth. Lacker preferred to expand the money supply “by purchasing U.S. Treasury securities rather than through targeted credit programs,” the FOMC statement said.

Buying Treasuries would reduce yields on government debt, prompting a decline in rates on mortgages, corporate bonds and other types of borrowing, according to Lacker and some other policy makers.

Still, there’s no guarantee the purchases would work, given that cuts in the Fed’s main interest rate failed to pare costs for corporations and other borrowers. Also, money created by the central bank to buy the Treasuries may fuel inflation should the Fed fail to quickly unwind the purchases as the economy begins to rebound.

‘Higher’ Bar

“The bar is a lot higher than we thought,” said Brian Sack, vice president at Macroeconomic Advisers LLC, and a former section chief at the Fed Board. “The statement said they are going to employ all available tools and yet they are reluctant to use the tool that is most readily available.” The FOMC next meets March 17.

Rates on long-term Treasuries have climbed this year as investor hopes faded for a quick start to Fed purchases. The yield on the 30-year government bond was 3.70 percent today, compared with 2.68 percent on Dec. 31. The yield on the 10-year note was little changed at 2.99 percent.

Costs for home loans are also rising. The average U.S. rate on a 30-year fixed mortgage increased to 5.25 percent last week from 5.10 percent the previous week, housing-finance provider Freddie Mac said on Feb. 5. In the week ended Jan. 23, mortgage applications in the U.S. slumped by the most in 16 years as refinancing plunged.

Fed purchases of Treasuries would sustain demand amid speculation China and other nations may curtail their holdings in U.S. debt, said Bill Gross, co-chief investment officer of Pacific Investment Management Co., the world’s biggest bond-fund manager.

China Investment

China is the largest investor in U.S. government securities, holding $681.9 billion of Treasuries.

“To the extent that the Chinese and others do not have the necessary funds, someone has to buy them,” Gross said in an interview with Bloomberg Television. “It is incumbent upon the Fed to step in. If they do, that will be a significant day in the bond market and the credit markets.”

Investors were disappointed when the Fed didn’t announce plans to buy long-term Treasuries in its Jan. 28 statement. The yield on 30-year Treasury securities rose 17 basis points to 3.41 percent that day. A basis point is 0.01 percentage point.

“What are they waiting for?” said Mark Spindel, who invests about $100 million as chief investment officer at Potomac River Capital in Washington. “I don’t understand this resistance from the Fed. Mortgage rates are now beginning to rise.”

Corporate Borrowing

One index shows the premium for corporate borrowing costs over 10-year Treasuries. While the spread has narrowed to 5.19 percentage points since reaching a high of 6.22 points on Dec. 16, it’s still more than triple the average spread of 1.66 percentage points in the year before the credit crisis started in August 2007.

As of Feb. 4, the Fed had bought $7.38 billion of mortgage- backed securities, out of $500 billion authorized, and $29.9 billion of debt issued by Fannie Mae, Freddie Mac and Federal Home Loan Banks, out of a possible $100 billion.

The Fed plans this month to announce a start date for the Term Asset-Backed Securities Lending Facility, or TALF, to prop up the market for student and auto loans, credit-card debt and small-business lending.

The Fed will release minutes of the Jan. 27-28 FOMC meeting on Feb. 18. Bernanke will testify before Congress on Feb. 10, give a speech on Feb. 18 and provide semiannual testimony on monetary policy to the Senate and House starting Feb. 24.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net; Craig Torres in Washington at ctorres3@bloomberg.net.

Last Updated: February 9, 2009 06:12 EST