Month: June 2014

The GOP May Begin Reconsidering Entire Economic Platform

Mark Tuminello’s latest blog post –

mark tuminello pethokoukisThomas B Edsall yesterday published an op-ed piece in the New York Times about the Republican’s party new in-fight – their entire economic platform.  This is a bigger fight than gay rights and immigration reform – is it true?  Edsall gets his information from an article from The Week by the American Enterprise Institute’s James Pethokoukis.

Pethokoukis has written a scathing article of an economic manifesto by Ted Cruz, Mike Lee, and Ed Meese, all big names in the GOP.  Pethokoukis calls the manifesto tired, stumbling, and ignoring the facts that taxes will need to be raised someday because of a rising elderly population and that there is no evidence of a debt crisis in the United States.

In this debate, Pethokoukis represents conservative thinkers who have evolved, looking for alternatives to broad, far-right policies and goals.  Along with Michael Gerson, and Peter J Wehner, he wrote a piece for the journal National Affairs called A Conservative Vision of Government, which goes against typical tea party thought that all government intervention is inherently a bad idea.

This new right sees the dominant economic thinking of the Republican party as overly negative about the government, coming from a kind of apocalyptic view of life in modern America.  They point out that this kind of economic philosophy that would abandon those who can’t help themselves, to allow injustice to occur to the weakest members of society, is a failure of American principles.  Recent stalling of upward mobility can even be attributed to this, they admit.

This could represent the beginnings of real reform in the party, but many are doubtful any Republicans really want to take on the tea party head on.  These reformers are being described as too timid in their efforts to shake up the parties strongly-held beliefs about economics.  They say it goes beyond ending a blanket opposition to taxes in any form.  It’s really about changing a culture in which there is no attachment or empathy for the poor and the weak of society.

That said, the dissenting voices are significant.  The GOP are worried about working class voters in the north and the midwest, particularly in the coming presidential election.  More and more these voters are not seeing the deficit as an equal problem to the suffering economy.  How long will they support cuts to entitlements and no tax raises on the rich?  These dissenters could be just the thing the party needs to win back these voters before they defect.

from Mark Tuminello

What Is Risk Reversal?

mark tuminello risk reversalRisk reversals can be used in a number of situations.  They are sometimes in the form of delta hedging, when an investor wants to protect assets from downside risks in price.  He wants to buy a put.  If he is okay with limiting his upside potential on the starting asset, it’s possible to sell a call to finance the purchase of the put.  It is thusly possible to create a position at no initial cost, one that is protected from major downside price movements.

Risk reversals are basically a put of a strike traded against a call of a higher strike.  So a 95/105 risk reversal means that 95 puts are bought and 105 calls are sold (or the puts are sold and the calls are bought).  More often than not, the put and the call options are out-of-the-money upon initiation of the risk reversal.

Another time someone would consider a risk reversal is as a way to get trading option skew.  If the trader things that the ratio of puts to calls is too volatile, it might be smart to consider selling puts to buy calls.  That’s a risk reversal.  Because a trader will be more interested in the volatility than the dollar values, he will delta hedge the combo (another term for risk reversal) when executed as a skew play.  In this way, the delta hedge serves the risk reversal as a way to focus the exposure to volatility.  Delta hedging options, lest we forget, means the strategy hinges on volatility instead of directional movement.

Here’s an example of when a trader would price a risk reversal as a skew trade, making him more interested in the implied volatility levels.  If his model uses volatility levels of 25 percent for the put, 20 percent for the call, he will consider whether the put is too high or low.  It’s important that his model is very accurate in terms of implied volatility.

Pricing and managing risk reversal is one of the more difficult option strategies.  It helps to select the combo with the put and call at similar levels of vega, gamma, theta, vomma, and vanna.  This way, many of them will cancel each other out.  This tactic is often used when combos are used as skew trades.  The trader can in this way minimize exposure.

from Mark Tuminello – latest post by Mark Tuminello