The impact of Brexit will not be understood for a few years but the initial signs are quite encouraging with markets having bounced strongly this week. On Saturday morning all of the commentary was that we had entered a new world called “post Brexit” and that the good old years of “Pre Brexit” were behind us…. but then again that was just the media and they must hold some responsibility for this whole exercise. One can only imagine some of the diatribe written in the Sunderland Gazette playing on peoples fears carrying stories on immigration but being lazy on the economic impacts if a YES Vote.
As we’ve seen in the last couple of days, markets tend to look through the headlines and focus on the future. While the impact of the Brexit is still very much unknown, the impact is unlikely to be anywhere near as bad as the media was playing it up to be. It was interesting to see one of Australia’s best investors, Hamish Douglas of Magellan, say yesterday that he believed there was a 25% chance that the UK does not leave the UK despite the referendum. All we know is that this is going to be a very long drawn out process.
Bloomberg British pound index and the effects of Brexit – 12% fall intraday
So here we are and we still have many of our strongest stocks moving higher and the weakest stocks moving lower. It’s a time to keep a cool head and commit to your investment strategies. The problem is that when we trade, it’s so easy to slip into ‘drunk monkey mind’. That’s when fear and greed take over, and otherwise rational people turn into impulsive maniacs. When the drunk monkey mind takes over, we do stuff like chase moves, miss winners because we fail to pull the trigger, and take only small profits while letting losers get massive. This makes it all the more important to stick to your strategies despite market noise.
Volatility spiked towards the end of the month but we are already starting to see it subside – this is not to say that the market won’t be volatile and we expect to get a more definite lead on the market over the coming week. See chart below. Each spike below correlates with a good buying opportunities in market.
Assuming that Brexit is a storm in a teacup (a very big political storm) the natural reaction globally has already been seen. Yellen is talking about keeping rates slower for longer (buillish), the BOE is looking to add further stimulus into the market (bullish) and locally there is discussion around another interest r mate cut (bullish). At the end of the day we have seen the central banks fight off most headwinds they have faced.
Gold has been a big beneficiary through this period as lower interest rates has fuelled buying globally and recent uncertainty has acted as a catalyst to push it to fresh highs. However we are cautious on gold in the short term as buying in the aftermath of Brexit has failed to push it higher and it has slid back from its initial Brexit surge.
Growth Portfolio
At the start of this month we only had 2 open positions in the growth portfolio. These were on MQA and NDQ (Nasdaq ETF).
Macquarie Atlas (MQA) has exposure to the European markets within its portfolio with assets across four countries including
Autoroutes Paris-Rhin-Rhone (APRR) in France, Dulles Greenway in USA, M6 Toll in UK and Warnow Tunnel in Germany.
The nature of these assets it defensive in nature and we were comfortable holding these as the direct effect of Brexit was limited. We currently have a trailing stop near recent lows.
REA was added to the portfolio on a strong technical break above medium term resistance.
We are currently up nicely on both of these positions and believe the momentum is to the upside on both of these stocks.
For the month we outperformed by 2.3%. This was due to our underweight view on equity markets . This leaves us with a Financial year return of 13% compared to the index of -4.13%. Since inception we are now showing out-performance of 29% against the XJO top 200
Income Protected Portfolio
The month of June proved to be a bumpy one for global financial markets with the much anticipated UK referendum taking place resulting in a surprise ‘Brexit’ that many didn’t see coming.
Our Income Protected Portfolio has weathered the volatility exceptionally well as downside risk is limited and our investments are fully protected.
We added one new position this month which was on Stockland Group (ASX:SGP) as it’s in a sector of the market that has outperformed the index over the past 12 months, is in a strong uptrend and has a healthy yield of 5.2%.
We purchased the stock in early June at $4.55 and bought put protection out to March 2017 with a strike price at $4.40 and paid $0.40 for each option purchased.
This put option is our worst case scenario sale price. Any fall below this point won’t affect our position as we essentially have an insurance policy that will enable us to sell our shares at $4.40 at any time we like between when the options were purchased at the start of June until the option expires in March next year. SGP will pay 2 dividends with in this time frame and this alone will offset the cost of the put protection almost entirely.
The Income Protected Strategy (IPS) generally involves simultaneously purchasing the stock and put protection and also selling call options over the top to help offset costs. In this instance we elected not to sell the calls as we’re of the view the share price is going to increase in the near term and we’d ideally like to take advantage of this move by selling calls at a higher level essentially giving us the ability to book in a much larger profit.
Our view has so far been correct so it is likely we will take action and sell the call options in the near term as this will add value to the overall position.
We booked in healthy profits on both Sydney Airports (ASX:SYD) and CSR (ASX:CSR) which both resulted in net profits of 15.8% and 4.8% respectively.
SYD we purchased at the beginning of September last year and CSR we purchased on February 26th 2016.
Both stocks far outperformed the market resulting in strong profits in what has otherwise been a very volatile market.
We continue to hold TWE, CBA, TCL, TLS, SUN and now SGP in our IPP (Income Protected Portfolio) and are looking for other opportunities as a result of the recent sell off caused by uncertainty surrounding ‘Brexit’.
For the month we outperformed by 2.34%. This was due to our underweight view on equity markets . Since inception we are now showing out-performance of 14% against the XJO top 200.
The Return of Volatility
June saw the return of volatility as traders became concerned about the Brexit decision. Notably however volatility levels did not reach the levels we saw in January & February when there were global growth concerns over a weakening China. It has been an interesting week with falls last Friday & strong gains over the past 3 days to recover a large chunk of the losses. Volatility rose quickly and is now starting to ease back again.
For options trading the increase in volatility presents us with more trading opportunities. Options are like a 3D Chess game with price, time and volatility being the three dimensions.
When volatility increases options become relatively more expensive and in low volatility they become relatively cheap. Volatility also differs a lot between different stocks and indicies, so it is important to consider volatility levels in the context of where it currently is compared to its normal trading range. Opportunities exist when volatility is trading at the extremes of those ranges.
Given volatility is one of the key inputs into option prices so in times of rapid change it becomes critical to be on the right side of it, as a small move in volatility can result in a significant change in the option price.
When Vol is high we want to be trading strategies which are effectively short or neutral volatility. This includes vertical spreads (neutral), and selling of naked options (short vol). To give an example we have seen volatility in Macquarie Bank options spike about 30% from levels last week into the start of this week.
We saw MQG $61 puts rise from 16c last Wednesday, to $1.10 on Monday. MQG shares had a large move going from $76 to $67, however if volatility had remained constant the price of the options should have been $0.55, rather than $1.10. So in this case the increase in volatility resulted in a doubling of the option price.
Now we are seeing volatility fall in Macquarie Bank which is when you want to be selling options. If you sold $76 MQG calls on Wednesday for 40c, you could be buying them back 2 days later for 20c, thus the fall in vol has resulted in a near halving in the option price in the space of 2 days (there will be a small time decay factor as well)
Essentially what we are doing with our strategies is constructing trades to take advantage of selling volatility in times of relative high vol, and favouring buying volatility when its cheap in times of low volatility.
For more information on our strategies or to speak to a Portfolio Manager, please call 1300 220 360 or send us an email invest@vfsgroup.com.au
Disclaimer:
This Communication has been prepared by Vertical Capital Markets Pty Ltd (ABN 11 147 186 114 AFS Licence No. 418418) trading as VFS Group (VFS Group).
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