#writing Reviewing gold miners, Strategy, the Dollar, German stocks, and the S&P 500 --- **March 10, 2025** After a week like last week, it is important to do a round up to answer the general question of "_what the h3!! just happened?_" Instead, we are going to [[CHG Issue 181 Marbles and Water|substitute]] that question, not for an easier one but for a better one: what changed? ## Newmont’s Failed Upside Breakout First up, we [[CHG Issue 180 The Neve Console|previously]] discussed a trade in NEM that we did a few weeks ago so let's check in to see how that is going. The overall position is down 170bps as the calls dropped by 9.3% while the underlying is down 7.6% from when we put the trade on. This is mostly because we underhedged a bit remaining long delta and from the time decay of the options. We gained roughly 140bps from the increase in back-month volatility, despite near term vol collapsing, and from carry from freeing up cash. From a purely option trading standpoint this was not a great trade as the synthetic put has massively underperformed the actual put. If we had just bought the put, effectively turning our position into a synthetic call we'd be up 41bps. The difference between the two mainly comes down to a directional bias to this trade. By buying the puts outright we would have gotten net short NEM and increased our aggregate position size, however by selling the underlying and replacing that exposure with calls we decreased our aggregate position size and _increased_ our net long in NEM. That directional bias was intentional, and the resulting P&L differentials are to be expected. However, as we hinted earlier when reviewing this trade we thought owning the OTM calls provided us a way to express that directional bet with less aggregate risk and better convexity. Given the failed upside breakout in NEM and the mechanical bounce off support the odds of a move back to the local lows increases and we have minimized our losses in that scenario to the call premium. Granted, buying the puts outright would still have been more profitable, however, we intentionally wanted to maintain a net long. The announcement of a class action lawsuit against NEM caused the failed upside breakout and an initial _drop_ in implied volatility. The sharp drop in vol was concentrated in the front months where the term structure had been steeply inverted and has since flattened substantially. This shows us that the move lower was a stabilizing move and as the market has stayed in the local range out month vols have increased and call skew has expanded to balance out the drop in ATM vol. This shifts the implied distribution to the left with the modal outcome now in the $38-$42 range for August but also cushions the option value of our calls as call skew expands due to a move higher being destabilizing. This leaves us with an excellent convexity profile on our underwater calls. ![[Pasted image 20250309164928.png]] ![[Pasted image 20250309164940.png]] ## MSTR Now lets check in on another name we've [[CHG Issue 174 Harvesting Crypto Volatility|written about recently]] and everyone's favorite software company turned cryptocurrency manager: MSTR or “Strategy”. ![[Pasted image 20250309171309.png]] Back in November Strategy issued a $3 billion convert issue which just happened to mark the local peak for MSTR but not quite for Bitcoin which hovered between 90k and 110k before breaking below 90k recently. The convert holders care more about the realized vol of MSTR and the recent drop in realized MSTR vol to the 115% area drops their realized coupons to an estimated 8-9% from 20+% at issuance. ![[Pasted image 20250309170739.png]] Now, the convert holders may also be hedging in spot Bitcoin which has delivered higher realized vol recently, but I have not modeled out what their realized coupons would look like by utilizing Bitcoin because it is a much more complicated exercise and highly dependent on the MSTR/BTC premium which has come in some with MSTR off nearly 50% from the highs and Bitcoin off only 25%. ![[Pasted image 20250309171401.png]] ## FX The dollar has been ping-ponging between the February 2023 low and March 2023 high for two years now and after the latest failed upside breakout the February low is our new downside destination. ![[Pasted image 20250309211435.png]] However, this time around it is happening with foreign stocks breaking out to the upside. Last week the EFA was up 3.49%, led by Germany, while the SPY was down 3.10%, led by economically sensitive sectors, which all of the sudden got everyone talking about a paradigm shift in Europe and a recession in the US. **Narrative always follows price.** ![[Pasted image 20250309220243.png]] The plates under the surface have been moving in this direction for some time though: the European Parliament elections last year [saw significant gains for right-wing parties](https://apnews.com/article/european-union-far-right-trump-us-elections-7356075127d7889cb670cfa25367ecdc), Germany's far-right party, the AfD, achieved its best-ever result taking 152 seats in the Bundestag, making it Germany's second-largest party; while the US's economic dominance has been weakened by high debt levels, weak aggregate income growth, and rising wealth inequality. The new Trump Administration's agenda has now kick-started Germany into action with Germany's next likely chancellor, Friedrich Merz, vowing a major expansion of defense and infrastructure spending which hit bunds and propelled the DAX higher. ![[Pasted image 20250309220405.png]] Always the keen eye, [Kris pointed out](https://x.com/KrisAbdelmessih/status/1897541535132238196) how euro stocks and vol were both up on the move last week while put skew remained bid. When vol increases with a directional move you should expect to see the distribution reprice in Bayesian fashion to account for the new information received which in this case is that an upside move is destabilizing for the market. To reprice, you would expect the skew for a counter-directional move to be flatter because that offsetting move in price is a stabilizing event for the market. This reasoning is why option traders love the [[CHG Issue 39 Monty Hall|Monty Hall Problem.]] Increasing put skew counterintuitively lowers the probability of the market moving lower whereas decreasing (or inverting) skew increases the probability of a directional move up (for call skew) or down (for put skew). What happened in FEZ was that downside skew remained bid which means the market is pricing a lower probability for a mean reversion trade to the downside than normal. This creates an opportunity to buy cheap put spreads to efficiently hedge any long exposure or just for speculative reasons. ## Stocks & Vol US economic dominance has been the norm for a long time and may have found an excess sentiment high last year amidst the [[CHG Issue 158 The Third Law|Mag 7 and Nividia hoopla]] which resulted in that little correlation unwind that we saw in August. That may have been the starting gun for what is now unfolding. ![[Pasted image 20250309215845.png]] As the market advanced from the August low, it became increasingly weak (lower volume, narrower investor participation, weak structure) and this recent sell off looks corrective, or like long liquidation instead of new real money selling. Sometimes markets can just get too long and need time to reset and consolidate and so far, that appears to be what is happening. Even if we see a recession, we could easily see a pull back like what we saw in 2022 without dramatically changing the long-term trend. Foreign markets attracting marginal investment dollars aligns with the signal of long liquidation that we are seeing but if it persists it could challenge the long-term trend but that will take time to reveal itself.  As the market sold off last week, we saw the expected increase in vol, however the increase was concentrated in the near-term expiries which inverted the term structure and there was not an expansion in put skew. This signal aligns with the reading of long liquidation as well because it shows lowers odds of a meaningful change in the primary trend. Call skew inverted further which, combined with the relatively unchanged, but steep put skew shifts the distribution to the left, meaning the market is implying a higher probability of remaining within the range between the 200d and the local high. The model density distribution below assumes steeper put skew and less inverted call skew than the market is currently pricing and shows that if skew had acted as expected we’d see the market pricing in higher probabilities of upside scenarios. ![[Pasted image 20250310095716.png]] ![[Pasted image 20250310095923.png]] Nothing seems out of the ordinary here, however if you have a directional bias the market is offering decent odds on the upside. We could also frame this as the market is begging us to get long, which is exactly what markets are supposed to do: balance supply and demand. ## Economic Policy The reason the market is looking for buyers is that there is a bit of panic over tariffs and a potential recession. Leading up to and shortly after the election the conventional wisdom was that the tariffs were just a negotiating tactic, and Trump wouldn't risk the stock market and economy for them. This thinking was linearly derived from the first Trump administration which was a huge cheerleader for the stock market and Trump himself tried to take a strong stock market as an endorsement of him and his policies. This created a very fragile situation where market expectations were at risk of being disappointed and sure enough last week, and this weekend the Trump and his administration signaled that they wouldn't prioritize the stock market and were willing to pay the price of a recession to rebalance the global economy in America's long-term interest. So now the markets are moving to price in a small recession and/or a retracement in stock prices but one that will eventually make the economy stronger and keep the long-term trend intact. The pricing we have observed above neatly aligns with this fundamental logic and reveals what the recent market action is reflecting. The important thing to do from here is draw inferences about the second order effects of these changes. One door has been opened and now we must adjust our prior probabilities about what may happen next. In thinking this through it's important to recognize that this administration's economic policies are like the policies pursued by Andrew Mellon in the beginning of the 19th century. He advocated for a balanced budget and protective tariffs and was generally not in favor of government stimulus. The goal of this policy mosaic is to increase corporate profits by increasing domestic production. The Trump tax cuts are intended to cushion corporate profits as their expenses increase from reshoring production, but that expense increase will also increase aggregate wealth and consumer spending which should create a virtuous cycle of higher spending and production. The economy will adjust to higher wages and prices and the primary avenue to balancing the budget is through cutting expenses. We have tax cuts financed by fiscal austerity and the hope is that their combined impact offsets and that after a short adjustment to higher prices and wages the domestic engine of consumption and production can lift us to new heights. This is the plan, but as Mike Tyson says: "Everyone has a plan until they get punched in the face."