Tag Archives: alternative

Riding The Petchem Boom With A Utility

Summary Entergy Corp. is a utility operating in the heart of America’s petrochemical boom. Entergy plans to steadily grow both earnings and dividends through 2018 at least. Shares are undervalued and I believe Entergy is a buy. The ‘shale boom’ just might be turning into the ‘shale bust’ as we speak, but the petrochemical boom is alive, well and durable. That’s because natural gas and natural gas liquids, inputs for the petrochemical industry, are now cheaper in America than anywhere else. This gives the U.S. a major advantage over other countries. The American petrochemical industry is really focused on the eastern Texas-Louisiana Gulf Coast. Not surprisingly, petrochemical plants and LNG export facilities are springing up all over the area. This boom is driven by demand, not supply, and so lower gas prices only help this growth trend. Investing in end-use chemical producers or LNG exporters is one way to participate in this trend, but utilities are also a low-risk way to be involved in this. Entergy Corporation (NYSE: ETR ) is the perfect company for this, in my opinion. Entergy generates power in New England from a handful of nuclear power plants, but the bulk of Entergy’s business is in generation and transmission of power in Mississippi, Arkansas, eastern Texas, and Louisiana. Louisiana is the largest piece of Entergy’s business, and, importantly, Entergy supplies much of the petrochemical industry along the Gulf Coast. Best of all, Entergy now yields over 5%, and has recently begun increasing its dividend as a result of the economic growth in its service areas. Solid growth and reliable income Some of Entergy’s industrial customers use as much power as a small city, and currently there are several plants being built along the Gulf Coast. This includes Cameron LNG in Louisiana, a Sasol cracker/chemical complex, two methanol plants under construction in Texas and Louisiana, and one steel mill under construction in Arkansas. (click to enlarge) Courtesy of Entergy Corp Investor Relations. The key ingredient to the industrial boom in this region is cheap, reliable energy. Louisiana and Arkansas have no renewable energy mandate. Texas does have one, but it’s not very big. Therefore, it’s no surprise that there’s three states have among the lowest electricity costs in the country. Low electricity prices entice these big industrial customers into this region and, as we will see, this in turn brings more residents and more efficient power distribution. It’s a virtuous cycle not often seen in the U.S. anymore. What does that mean for us? Well, it means 2% load growth for residentials and 4% growth for industrials, each year, through 2018 at least. (click to enlarge) Courtesy of Entergy Corp Investor Relations. Currently Entergy’s dividend is 57% of earnings, on a per-share basis. Over the last twelve months, Entergy has generated only $509 in free cash flow, but has paid $617 million in dividends. That, however, is because Entergy is building up its generation capacity with several power plants. Once the first new plant is up, St. Charles power station, Entergy will have much more financial flexibility. I fully expect Entergy to continue raising its dividend by low single digits through 2018, and perhaps even more in the following years. Valuation and conclusion (click to enlarge) Courtesy of Entergy Corp Investor Relations Is Entergy a good value right now? I believe it is. According to FAST Graphs, Entergy trades at 11.3 times earnings, which is quite a bit lower than the stock’s ten-year average valuation of 13.4 times earnings. That’s a 15.6% discount to its full-cycle average valuation, and there’s no reason Entergy shouldn’t achieve at least that average valuation. When you add a 5.1% dividend onto that, there’s a lot to like about this utility. Here’s what you’ll get with Entergy: A steady-growth utility in an economically strong area. As a utility, the barriers to entry in this industry are very high, which puts a lot of safety into this name. For these reasons, I believe Entergy is a buy right here.

Neuroeconomics And Volatility

Summary Discussion on the summer spike in volatility in relation to the three areas of neuroeconomics. How your brain and emotions affect volatility decision making. I have preached patience and the science agrees. First, thank you for reading my articles. I have great readers, as shown by the comment sections of each article and I really appreciate all of you. If you enjoy my work, please follow me on Seeking Alpha and feel free to link to or share this article. In this piece, we will look into some very interesting research in economics and how that relates to volatility. Long-Term Volatility Trends I have always asserted that the VIX is driven long term by actual and predicted economic growth and short term by a variety of factors. If you look at the long-term chart below showing the VIX Index, you will see a slight correlation to the level of volatility and the performance of the general economy that generally agrees with this theory with a couple of exceptions. (click to enlarge) (click to enlarge) Let’s state the obvious here: if the economy is doing well or expected to be doing well, then volatility will tend to be lower and vice versa. This is a longer-term view of overall volatility. However, many other short-term events will produce better opportunities to profit from spikes in volatility when using VIX futures ETFs. Neuroeconomics This is something we haven’t discussed before in regards to volatility. This field of study seeks to explain human decision making, the ability to process multiple alternatives, and to follow a course of action. Neuroeconomics textbook definition fits very well into volatility trading. To compare volatility trading to neuroeconomics, we will use Jason Zweig’s book Your Money & Your Brain as a resource. Our First Lesson Monetary losses and gains are not just pure financial and psychological outcomes. These gains and losses create a biological change which has substantial effects on the brain and body. When trading volatility, it is important to understand and plan for the potential gains and losses of a given scenario. I am sure many people reading this article had been in a trade before and wondered things such as: how the heck can this be, this is out of control, the market is dumb, people are idiots, and then why did I even make that decision. On a daily basis, I see comments on social media that lend more to the premise of impulsive gambling rather than strategic investments in volatility. Areas of the brain linked to excitement and anxiety influence our financial decision making. Those decisions can be rational or irrational in nature. The nucleus accumbens is an area of the brain that activates when we expect a reward, such as a profitable volatility trade. Financial reward will most often cause traders to make decisions based on emotions and potential outcomes rather than the evidence at hand. According to Stanford University , the nucleus accumbens is located in an area of the brain rich in dopamine which has been linked to addiction. If you are only focusing on the reward of your volatility trade, you are leaving out 75% of the equation. How can you make a successful financial decision while encouraging your brain to release dopamine? Loss Aversion Loss aversion is the theory that individuals will exhibit greater sensitivity to losses than to an equivalent gain. I recommend reading The Neural Basis of Loss Aversion in Decision-Making Under Risk. In the past several years, investors have enjoyed above-average gains for an extended period of time. This pushed inverse volatility products such as the VelocityShares Daily Inverse VIX ST ETN (NASDAQ: XIV ) to new highs and leveraged long volatility products such as the ProShares Ultra VIX Short-Term Futures (NYSEARCA: UVXY ) to new lows. It also created pockets of writers who openly touted inverse volatility products as the best trading vehicles ever (more on those results later). Let’s view a market chart and the performance of XIV from 2011 to mid-2014. It is important to note the Y axis in this chart and that the gains in XIV would have been 10x the amount of the S&P over this period of time. Graph mainly for illustration purposes of increasing gains. You can see that a clear upward trend was in place until July of 2014. Beyond that point, the market, although making new highs, began to get choppy and growth fears began to emerge exponentially in the media. See below for July 2014 to present including the VIX Index. This chart shows the percentage of change and is separated by equity to give you a clearer picture of each instrument. VIX Spike Why would the VIX Index, and subsequently the VIX futures which affect volatility ETFs, spike to a level not seen since 2008 despite the lack of an actual recession? The answer is loss aversion. Investors were less willing to lose $5 than they were to potentially gain $5 after so many years of steady gains. Hitting the sell button is easy when you are up substantially on your original position or you fall into a growing category of investors that have never experienced a market correction. There was also no shortage of dire news stories about the economy and slow global growth, further supporting the neurological decision to avoid risk. We have previously discussed how UVXY operates and its tracking of the VIX futures. You can read more about UVXY and other volatility products in the ETF Guide . When the VIX futures were spiking this past summer, UVXY went on a tear and produced incredible gains in a short period of time. See below: (click to enlarge) During this time period, you had incredible interest in UVXY mainly coming from news features and a huge spike in social media volume. Bandwagoners looking to make a quick buck were sucked in. Some got out ahead, and others didn’t. By the time some traders realized they had made a mistake, the natural dopamine had long worn off and reality started to set in. Although unfortunate for them, these traders are an essential part of the volatility food chain in which the patient and well positioned survive. Conclusion I hope you have enjoyed this first lesson on volatility trading in relation to neuroeconomics. I look forward to bringing you more lessons as my schedule permits. To recap, we discussed how chemical and physical changes in the brain due to gains and losses on your investments influence the decision-making process. As volatility traders, we can take advantage of this information by clearly seeing through the market turmoil and making decisions based on evidence (past and present) rather than emotion. By understanding the parameters that volatility futures will trade in, the usual highs and usual lows based on the current scenario and historical figures, you can plan out your trade to encompass the three areas of neuroeconomics. By weighing all possible scenarios, you can be better prepared to follow through with your trade and increase the chances of profitability. As we have discussed, our natural instinct is to sell and save rather than to wait and gain. If I could pick the most common word out of my volatility articles here on Seeking Alpha, it would be patience and the science behind your decision making agrees. For more information on volatility trading and its related ETFs along with strategies and educational series, please check out my library here on Seeking Alpha. As always, thank you for reading!

Revisiting GoPro

Summary Shares of GoPro, a top stock pick of a social data startup in late September, tumbled to a 52-week low on Friday after an analyst downgrade. According to the social data startup’s co-founder, more recent social data on GoPro has been “concerning”. We look at the status of an October hedge on GoPro and discuss possible courses of action for hedged GoPro shareholders. Sourcing Securities For Hedged Portfolios In a series of articles earlier this fall, we wrote about constructing hedged, or “bulletproof” portfolios. The general idea of hedged portfolios is to buy and hedge a handful of securities that have high potential returns net of their hedging costs: if the securities do well, you’ll do well, and if they don’t, your downside will be strictly limited. Broadly speaking, there are two methods of finding securities to include in a hedged portfolio: Start from scratch, rank every hedgeable security by potential return net of hedging cost, and select the highest-ranked names with share prices suitable for the size of your portfolio (to facilitate purchasing round lots, which lowers hedging costs). This is the method Portfolio Armor’s automated hedged portfolio construction tool uses if you don’t provide security symbols of your own when using it. Start from a smaller list of securities, such as a list of recent purchases by top investors, the top holdings in a leading fund, or the top names surfaced by a firm with a quantitative ranking system. This a more feasible approach if you aren’t using an automated tool, since you will have fewer names to calculate potential returns and hedging costs for. In an October article (“Building A Bulletproof Portfolio Of Top LikeFolio Picks”), we built a hedged portfolio using the top picks of a startup called Likefolio. As we mentioned in that article, Likefolio aggregates social media mentions of brands, and ties them to the publicly traded stocks those bands roll up to. In late September, Likefolio highlighted five stocks as have having promising social data metrics: GoPro (NASDAQ: GPRO ), Michael Kors (NYSE: KORS ), Amazon (NASDAQ: AMZN ), Crocs (NASDAQ: CROX ), and Wal-Mart (NYSE: WMT ). One of those stocks, GoPro, has dropped precipitously since our article was published. In this post, we’ll revisit GoPro and discuss courses of action for hedged GoPro shareholders. GoPro Hits 52-Week Low Shares of GoPro, maker of wearable cameras such as the ones pictured above (image from the company’s website ) hit a 52-week low intraday Friday, after downgrade by Baird, as Mamta Badkar reported in the Financial Times over the weekend (“GoPro slopes back to the bush league after broker downgrade”). Badkar noted Baird had cut its price target on the stock from $36 to $18, and quoted Baird analyst William Power on his firm’s view of GoPro’s sales trend: “Our checks have not suggested a meaningful pick-up in GoPro camera sales.” A Former LikeFolio Top Pick As of Friday, December 4th’s close, GPRO is down 38% from when we wrote our LikeFolio article. Given the drop and the recent downgrade, I reached out to LikeFolio co-founder Andy Swan via Twitter over the weekend to see what his company’s current social data metrics were saying about GoPro. His response, as you can see in the image below, indicated the recent data wasn’t positive. Considerations For Hedged GoPro Shareholders Given the stock’s precipitous drop, the Baird downgrade, and the inauspicious updated data from LikeFolio, hedged GoPro shareholders may be considering their next moves now. We’ll look at the status of the October 9th GPRO hedge we included in our previous article below and discuss possible courses of action for GPRO investors. A Closer Look At The October 9th GPRO Hedge: The optimal collar below was designed to limit an investor’s downside to a drawdown of no more than 20% by mid-April, 2016, while capping his potential upside at 71.2%. The reason the cap was set as 71.2% was because 71.2% was the potential return calculated for GPRO at the time using the consensus price target of sell-side Wall Street analysts (since Portfolio Armor only calculated positive potential returns for two of the Likefolio picks included in our October article, AMZN and CROX, we used analysts’ consensus price targets to calculate potential returns for all of them). How That October 9th Hedge Responded To GoPro’s Drop Here is an updated quote on the put leg of the collar as of Friday. And here is an updated quote on the call leg: How That Hedge Protected Against GPRO’s Drop GPRO closed at $29.08 on Friday, October 9th. A shareholder who owned 1800 shares of it and opened the collar above then had $52,344 in GPRO stock plus $9,990 in puts, and if he wanted to buy-to-close his short call position, he would have needed to pay $1,548 to do that. So, his net position value for GPRO on October 9th was ($52,344+ $9,990) – $1,548 = $60,786 GPRO closed at $18 on Friday, December 4th, down 38% from its closing price on October 9th. The investor’s shares were worth $32,400 as of 12/4, his put options were worth $18,450 (using the bid price of $10.25, to be conservative, as that particular put option didn’t trade on Friday) and if he wanted to close out the short call leg of his collar, it would have cost him $198. So: ($32,400 + $18,450) – $198 = $50,652. $50,652 represents a 16.7% drop from $60,786. Slightly More Protection Than Promised So, although GPRO had dropped by 38% at the time of the calculations above, and the investor’s hedge was designed to limit him to a loss of no more than 20%, he was actually down only 16.7% on his combined hedge + underlying stock position by this point. Courses Of Action For Hedged Sketchers Shareholders Being hedged gives an investor breathing room to decide what his best course of action is. A GPRO investor hedged with this collar could exit his position with a 16.7% loss now (instead of a 38% loss), he could wait to see what happens, or if he remains a long term bull, he could buy-to-close the call leg of this collar, to eliminate his upside cap. If he’s even more bullish, he could sell his appreciated puts, and use those proceeds to buy more GPRO. When backtesting the hedged portfolio method , we tested variations of the first two of those four scenarios. Specifically, we looked at securities that fell below the decline threshold we hedged them against (which was 20% in the case of GPRO), and whether, on average, hedged portfolio performance was better if those losing positions were exited 3 months into the duration of the portfolio, or held for 6 months, or until just before their hedges expired, whichever came first. We found that, on average, investors were better off holding their losing positions for six months or until just before their hedges expired, whichever came first. Tradeoff: Time Value Versus Time for Recovery The tradeoff involved there is this: the longer you hold the position, the more time the price of the underlying security has to recover; on the other hand, the sooner you exit the position, the more time value your in-the-money put options have (time value is why the GPRO hedge offered slightly more protection than promised in the calculations above). In this case, given that there’s not a lot of difference between the current drawdown (16.7%) and the maximum drawdown for this hedge (20%), GPRO shareholders hedged in this way may want to consider holding a bit longer. A positive surprise in holiday sales might boost the stock, while, in the worst case scenario, shareholders hedged with the collar above will be down another 3.3%.