Recession? Economic Data and Margin Rules – Oh My!

Alan Greenspan says we may be heading into a recession.

This is not something you want to hear to start the week but the markets are probably more comfortable hearing him get back to his usual "doom and gloom" prognosis than they have been with his recent "housing may be bottoming " BS that he’s rolled out as his last few appearances.

Greenspan getting optimistic about housing is sort of like Darth Vader asking you over for tea – you’d like to think he’s really changed but you still have trouble really getting comfortable with the situation.

We like our bad guys to be bad and our bears to act bearish – then we all know our place in the world and can act accordingly – it’s way too confusing when people start switching sides!

It’s a very busy data week so we’ll see how sharp Mr. G’s forecasting skills are as we get some biggies.  Here’s the list from Briefing.com:

ISM below 50 is an early sign that Greenspan is on track but hopefully he’s just being his grumpy old self, trying to counterbalance a doveish Fed outlook with a little rain on our parade.  He is taking the opportunity to speak out against the deficit, something he was not really free to do as Fed chief but his most interesting statement is that investor appetite for risk has led to risk premiums on financial assets being "extraordinarily low," which could pose problems in the future.

"We have extraordinarily low risk premiums now. Risk is no longer perceived as major risk, at least as it was in years past and that, I must say, I find disturbing," he said. "We do not and cannot look into history without being very concerned when you see the absence of awareness and concern about risk that we see today."

Let’s see if that can perk up the old VIX! 

This is interesting at a time when margin debt is at a new record but I’ve been mulling over the potential impact of the new virtual portfolio margin rules which go into effect on April 2nd.  On the whole, this should be great for us, as we mainly write covered calls but it depends how it is actually implemented by the brokers.  On the whole, the minimum margin requirement for securities will now be 15% OF THE ENTIRE Virtual PORTFOLIO, as opposed to the standard 50% of each security, this means you can buy more than 3 times more stock with the same money!

Even more significant to large traders and funds is that the collateral requirements now read across your whole account, as opposed to each individual trade.  This means that if you diversify your risk (like us) you will not get a margin call on your negative positions if they are offset by other positive moves.

EVEN MORE significant than that is the fact that protective puts will now virtually erase the margin requirements against your stocks.  If you take this week’s KMP example – currently, if you have $5,000 cash in your margin account, you can buy 200 shares of KMP at $50 each ($10,000).  If you protect yourself with puts, this does not change that formula.  Under the new guidelines, protecting yourself with 5 Jan ’09 $50 put contracts for $2,000 will allow you to buy perhaps 500 shares ($25,000) with that remaining $8,000 – it’s not clear how the brokers will interpret this but clearly the new regs do not consider your underlying security to be "at risk" when it is covered.

From the CBOE web site, we have these examples of potential strategies we can employ:

These are samples NOT recommendations!

COVERED WRITE

• Long 500 IBM @ $91.25 
  • Short 5 calls IBM APR 95 @ $ 2.78

Current margin is 50% of stock less the short option premium or $21,422.50, new virtual portfolio margin requirement is $5,504.00.

PROTECTIVE PUT 

• Long 500 IBM @ $91.25
  • Long 5 puts IBM APR 90 @ $ 2.50

Current margin is 50% of stock plus full payment for put or $24,062.50, new virtual portfolio margin requirement is $1,878.003 

DEBIT SPREAD