This articles is from @SahilBloom who is one of the best mentor about finance that willing to share all of his knowledge for free. So if you like the post, please give him a follow and share his lessons.
If you’ve been following the financial media, you may have heard @mcuban and @elerianm on @SquawkCNBC referring to the “Fed put” in the markets and its impact on asset prices. But what is the “Fed put” and how does it work?
When people refer to the “Fed put” in the markets, they are making reference to a put option.
In this context, the phrase “Fed put” is used to refer to the notion that stock buyers believe they have an ability to sell their assets to the Fed at a good price at any point in the future. The Fed has been clear it will support markets, so the notion isn’t without merit!
As @mcuban and @elerianm point out, this contributes to asset price inflation.
Why?
The Fed put acts as a hedge (downside protection!), allowing for more risk-taking to the upside. If you’re at the casino and your rich friend offers to cover your losses, you bet bigger!
The “Fed put” isn’t new. It was originally called the “Greenspan put” - a reference to former Fed chairman Alan Greenspan, who first engaged in expansive asset purchases during the 1987 market crash. I would argue it dates back further, to the “FEDerico put” of 1500s Italy!
Central bank market intervention is a controversial and highly-relevant topic. I hope this primer helps you feel more educated on the subject. With apologies to my Austrian economists
My Mom texted me recently asking, “What’s an ETF?” A financial advisor had pitched her on investing her money in a “diversified pool of ETFs” (to sound complex, obviously). But what is an ETF and how does it work?
Just think of an Exchange-Traded Fund (“ETF”) as a basket of goods. The goods are financial assets, such as stocks, bonds, commodities, etc. You can buy shares (partial ownership) of this basket. It’s similar to a mutual fund, but can be freely-traded, just like a stock.
ETFs can track sectors, asset classes, indexes, etc. They provide liquid (convertible to cash), low cost diversification. The biggest ETF isssuers are @blackrock (@iShares), @Vanguard_Group, and @StateStreetETFs.
The largest ETFs are $SPY $IVV $VOO (all track the S&P 500).
To illustrate how it works, let’s use a simple story. Imagine you live in a remote village in 1700s France. You don’t have access to the bustling street markets of Paris, you have no way of getting there. You want to trade in exotic goods, but you can’t.
Luckily, the richest man in town, Mr. ETFienne, has a plan. He rides to Paris in his carriage and buys a big basket of exotic goods. He offers you a share, on paper, of his basket. He takes your money (and a small fee for his trouble!). You now own one share ETFienne’s ETF.
You’re an exotic goods trader now. All without leaving the comfort of your own village! You paid 5 Livre (the 18th century French currency for you non-history buffs) for the one paper share. With it, you indirectly invested in a diverse basket of exotic teas and spices.
If war breaks out in the colonies and the prices of these goods become volatile, you can buy and sell the ETF shares to speculate on these price movements. If the prices are stable and growing, you can hold onto your ETF share to accumulate wealth.
“ETFs are great!” you say.
So as we see in this story, Mr. ETFienne’s ETF was just a basket of goods whose shares were freely-traded on an open market.
Why use ETFs?
- Liquidity
- Diversification
- Tax Efficiency
In summary, ETFs may be a better option than mutual funds for many investors.
If you follow the financial news, you've probably heard a lot of talk recently about the VIX. But what is the VIX and how does it work?
The Volatility Index ("VIX") was created by the Chicago Board Options Exchange as a real-time market index representing the market's expectation of 30-day forward-looking volatility. It is often referred to as the "Fear Index" by investors. Let's take a look at how it works.
Volatility measures the magnitude of price movements (up and down) over a set period of time. Historical volatility is based on actual historical price movements. Forward-looking volatility ("implied volatility") is inferred based on option prices.
The VIX infers its value by tracking the pricing of S&P 500 index options. But what do S&P 500 options prices have to do with investor fear?
When investors expect stock prices to make a significant move (up or down), they typically purchase more options to protect themselves against those movements. Think about it as buying insurance to protect your home if you’re expecting an earthquake to hit soon.
So in an environment where investors expect a big near-term price drop, it is reasonable to expect a surge in demand for put options.
There is more uncertainty in the market, so investors seek protection via these options. Demand for them rises.
If demand rises quickly, supply will not have a chance to catch up. Econ 101 tells us that the price of the options must rise. Since we know the VIX tracks the pricing of S&P 500 index options, we can see the relationship form. S&P 500 put option prices spike = VIX spike.
To use a real example, the VIX spiked to a peak of >80 in mid-March, as fears of COVID-19 damage peaked. It has steadily declined since, as Central Banks worldwide have eased investor fears. Typically, VIX values <20 correspond to stable, low-stress periods in the markets.
Since the VIX is an index, you cannot trade it directly.
But this is finance, so interested investors can speculate on movements in the VIX in a number of other ways:
1⃣ - VIX futures contracts 2⃣ - VIX options 3⃣ - VIX ETFs ($VIXY)
This articles is from @SahilBloom who is one of the best mentor about finance that willing to share all of his knowledge for free. So if you like the post, please give him a follow and share his lessons.
