Outside the Box

EVERYONE CANNOT BE RIGHT

In other words, the entire value of the financial sector (not just banks) in the S&P 500 is around just 15%. If all banks went to zero tomorrow, the index would only fall 15% further ...

There are some prominent economists who believe that equity stakes in large banks are ... valuable. The market, interpreted one way, is saying something else, perhaps.

The VIX, the volatility measure on the S&P500 broad stock index, is around 55%, today. That says that the standard deviation of the S&P500 is 55%, annualized. Assuming a distribution, you reasonably interpret that to mean that the S&P could drop 55%, without 'extraordinary' circumstances.

Now, I'll tell you, that price is so high, it is higher than if the value of all the equity of all the banks in the index was worth nothing. In other words, the entire value of the financial sector (not just banks) in the S&P 500 is just 15%. If all banks went to zero tomorrow, the index would only fall 15% further ... that's way less than 55%, right? Both cannot be right.

What to do?

---

BSDs UNITE

Sell covered calls, as big as you can, outside the financial sector ... If you are even more brave, sell puts. If you are just normal, just go long technology (or a diversified set of high-quality names). If you are creative, buy some high yield bonds. If you are a professional, pick some winners and buy them against the broad indexes. In other words, there are a lot of things to do.

The risk if you are wrong? As I see it, the stock market is already discounting a normal sized recession, plus or minus 4%. Your risk is really that the U.S. Economy collapses. Yes, there are extraordinary pressures on over-leveraged consumers and national finances are out-of-whack in a world that is contracting, but U.S. business balance sheets are in really good shape (as best I can tell). The chance that the financial system's equity is worth nothing is non-zero, but the chance that the entire financial complex ceases to function is slim, judged at this juncture.

[+/-] Show Full Post...

[+/-] Hide Full Post...