Introducing The Facebook National Bank

We had pointed out back in February as to how startups are disintermediating banking and that given the amount of data that both banks and Facebook have on us, it is only a matter of time that we saw a “Facebook National Bank.” Turns out that it is now a reality:

Facebook is readying itself to provide financial services in the form of remittances and electronic money. The social network is only weeks away from obtaining regulatory approval in Ireland for a service that would allow its users to store money on Facebook and use it to pay and exchange money with others. “Facebook wants to become a utility in the developing world, and remittances are a gateway drug to financial inclusion.”

Source: Facebook targets financial services

Opening Bell 16.04.2014

Your world at 9am

world equity markets 2014-04-16

Equities

Major
DAX(DEU) -1.77%
CAC(FRA) -0.89%
UKX(GBR) -0.64%
NKY(JPN) +2.26%
SPX(USA) +0.68%
MINTs
JCI(IDN) +0.29%
INMEX(MEX) +0.04%
NGSEINDX(NGA) +0.59%
XU030(TUR) -1.95%
BRICS
IBOV(BRA) -2.21%
SHCOMP(CHN) +0.12%
NIFTY(IND) -0.64%
INDEXCF(RUS) -2.52%
TOP40(ZAF) -0.83%

Commodities

Energy
Brent Crude Oil -0.19%
Ethanol +0.00%
Heating Oil -0.17%
Natural Gas -0.22%
RBOB Gasoline -0.54%
WTI Crude Oil +0.06%
Metals
Copper +0.00%
Gold 100oz -0.10%
Palladium -0.19%
Platinum -0.24%
Silver 5000oz +0.00%

Currencies

USDEUR:-0.01% USDJPY:+0.29%

MINTs
USDIDR(IDN) +0.10%
USDMXN(MEX) -0.09%
USDNGN(NGA) +0.00%
USDTRY(TUR) -0.13%
BRICS
USDBRL(BRA) +0.84%
USDCNY(CHN) +0.04%
USDINR(IND) +0.09%
USDRUB(RUS) +0.74%
USDZAR(ZAF) -0.08%
Agricultural
Cattle -0.15%
Cocoa -0.53%
Coffee (Arabica) -6.00%
Coffee (Robusta) -0.42%
Corn -0.50%
Cotton +0.32%
Feeder Cattle -0.08%
Lean Hogs +0.00%
Lumber +0.40%
Orange Juice +0.89%
Soybean Meal +0.31%
Soybeans +0.40%
Sugar #11 +0.00%
Wheat -0.39%
White Sugar +0.88%

Must reads

Infosys: Neither the company’s March quarter results, nor its guidance give signs that the company is out of the woods. (LiveMint) INFY 3,185.00 27.70 (0.88%)

The Grossman-Stiglitz paradox says that if asset prices perfectly reflected all information, then there would be no reason for anyone to collect information and trade assets, so asset prices couldn’t perfectly reflect all information.

Indexing is basically the contrapositive of the Grossman-Stiglitz paradox. If everyone tries to beat the market, then it will be hard to beat the market: You’ll be competing with everyone else to get information that you can use to outperform the market. If it’s hard to beat the market, it makes good sense to index. If everyone starts indexing, then it’s easy to beat the market: Nobody else is gathering information, so any information that you gather will make you money. (Bloomberg)

Modi has created huge hope and aspirations and any failure to deliver on these heightened expectations will be catastrophic for his personal ambitions.(Rediff) But be prepared to be disappointed. (What can Modi do?)

Good luck!

Trading Options, Know your Greeks

The first rule of trading options is that options are not stocks. Just because the underlying stock moves doesn’t mean that the option moves in the same direction. You need to think of options as a separate asset class.

For example, if you are in a ship at sea, you know that the tides are linked to the phases of the moon. But the tides are only a small part of what is involved in sailing, isn’t it? You should also know about ocean currents, developing weather patterns, presence of icebergs, reefs, etc… Similarly, the option premium is only lightly tethered to the value of the underlying.

The key thing to remember is that the option premium is a function of intrinsic value, time value and volatility.

Lets say you buy a April NIFTY 6750 Call @ Rs. 59.70 when the NIFTY was trading at 6733.10. Say, the NIFTY rallies by 1% to 6800.431 the next minute. Would your call option also increase by 1%? Nope. It will probably tick up by 0.5% Why? because the delta(δ) of that option is 0.49

But what if the NIFTY rallies tomorrow by 2%. Will your call option premium now increase by 1%? Nope. There are two opposing forces that are now acting on the option.

The first, and the strongest force, is time decay. It is known to crush the best laid plans of both men and mice.

The second, is volatility. As a buyer of an option, you want volatility to go up, and NIFTY rallying by 2% in a day is just that.

It is not only important to mind your greeks at the time of putting on the trade, but you need to monitor it constantly. Greeks change not only as the underlying moves, but also as expiration approaches.

Remember your Greeks:

Vega(κ) Theta(θ) Delta(δ) Gamma(γ)
Measures the impact of change in volatility (σ) Measures the impact of change in time remaining Measures the impact of change in underlying price Measures the rate of change of delta(δ)

Study reveals why economists suck at making predictions

The ability of forecasters to predict turning points is limited. Forecasts from the official sector, either from national sources or international agencies, are no better at predicting turning points.

So the explanation for why recessions are not forecasted ahead of time lies in three other classes of theories, which are not mutually exclusive.

  • One class says that forecasters do not have enough information to reliably call a recession. Economic models are not reliable enough to predict recessions, or recessions occur because of shocks (e.g. political crises) that are difficult to anticipate.
  • A second class of theories says that forecasters do not have the incentive to predict a recession, which – though not a tail – event are still relatively rare. Included in this class are explanations that rely on asymmetric loss functions: there may be greater loss – reputational and other kinds – for incorrectly calling a recession than benefits from correctly calling one.
  • The third class stresses behavioural reasons for why forecasters hold on to their priors and only revise them slowly and insufficiently in response to incoming information.

A more than a healthy dose of skepticism is always warranted when dealing with these so called “expert forecasts.”

Source: “There will be growth in the spring”: How well do economists predict turning points?

Trading Options

A brief history

The first options were used in ancient Greece to speculate on the olive harvest. It was mid-winter, and the owner of the olive presses was happy to sell the right to use the olive presses during the harvest season. It generated income for the olive press owner during the off season.

The man purchasing the rights ensured that he would have use of the presses during the busy season. If the olive harvest was really good, the purchaser might be able to even resell his right to use the olive presses for a profit.

The stock options of today appear to have made their debut in what were described as “bucket shops”. It wasn’t until 1973 that the modern financial options market came into existence. The Chicago Board of Trade (CBOT) opened the Chicago Board Options Exchange (CBOE).

Option pricing

The option premium is a function of intrinsic value, time value and volatility.

Intrinsic value: The intrinsic value of an option is the difference between the actual price of the underlying security and the strike price of the option. The intrinsic value of an option reflects the effective financial advantage which would result from the immediate exercise of that option.

Time value: It is determined by the remaining lifespan of the option and the cost of refinancing the underlying asset (interest rates).

Volatility: Higher volatility implies higher premiums as the probability that the option will expire in-the-money increases with volatility.

Some heuristics used to come up with a price for an option:

  1. make sure put-call parity is respected
  2. a call of a certain strike K cannot trade at a lower price than a call K+ΔK (avoidance of negative call and put spreads)
  3. a call struck at K and a call struck at K+2ΔK cannot be more expensive than twice the price of a call struck at K+ΔK (negative butterflies)

There are theoretical option-pricing models, the most popular being Black-Scholes-Merton (BS), that can be used to price options. However, the primary use of BS in the real world is to trade the greeks.

This Khan Academy video does a good job of explaining the BS model:

Put-Call Parity

The put-call parity states that a portfolio of a long call option and a short put option is equivalent to (and hence has the same value as) a single forward contract at this strike price and expiry.

put call parity

The intuition behind this is: Call + Cash = Put + Underlying Asset

The put-call parity provides a simple test of option pricing models. Any pricing model that produces option prices which violate the put-call parity is considered flawed.

Options on StockViz

The BS Model greeks for “on the run” strikes (strikes closest to the underlying) are available for all listed options on StockViz. These values are updated on the fly using the latest market information.

NIFTY options screen

You can place (dummy) trades by clicking on the green button. This will allow you to track your options P&L over the life of the trade.

Source:
Option Traders Use (very) Sophisticated Heuristics, Never the Black–Scholes–Merton Formula
A Short History of Options
Put–call parity
Relationship between put and call