JP Morgan Asia Confidence note

I was reading the papers, and this advertisment caught my eyes. It is called "JP Morgan Asia Confidence note". So I called up to check it out.


This structure is as follow :

1)Tenure of 2.5years

2)7.5%p.a coupon fixed – payable quarterly.

3)Based on Singapore, Malaysia, Thailand and Taiwan Indices movement.
Buffer level for Principal to be affected @ 50% - i.e. index must fall by 50% for
Principal to be affected.

4)Early callable every quarter.

On the face of it, this structured notes looks good, so I asked more questions on the product. This is what I understand from the marketing officer :

The product pay 7.5% p.a. coupon fixed on a quaterly basis, but is callable every quarter. What does this mean? This mean that if at every quarter, if the 4 indices are above the initial price, the bank has the right to "call" the product, i.e., the product will no longer exist as the bank will pay you the principal to redeem the product.

If throughout the 2.5 years, any one of the indicies fell 50% from the initial price, the trigger comes in. You do not know your loss at this point in time, because you need to wait till the end of the 2.5 years to see where does the worst index ends. If the worst index ends above the initial price, than no loss is incured. If the worst index ends below the initial price, the loss will be the difference between the initial price and the price at the end of 2.5 years.

It sounds complicated in words, so a decision tree illustration may be helpful :

Assuming that the initial price for all 4 indicies are 100, and the initial investment is $100,000. Than

Step 1: Did an early redemption event occur? i.e. ALL indices close above Initial Price

*If YES, Note is early redeemed, Noteholder receives 100% principal

*If NO, proceed to next step



Step 2: Did a Trigger Event occur?i.e. Is conditional principal protection still valid? Did any Index close below 50% of their respective Initial Price?

*Note: There is NO need to proceed to step 3 if Step 2 does not occur.

Step 3: At maturity (Final Valuation Date), did Straggler (least performing index) close above its Initial Priceof 100?

*If YES, Noteholder receives 100% principal, i.e. $100,000.

*If NO, Noteholder receives (Straggler Final Price / Straggler Initial Price) x Principal.

Assuming that the final price of the worst index is say at price 60, than you receive $60,000 plus whatever coupon you received before the expiry date.

Is this a good product? Well, it really depends on your view of the market. Let me explain.

Because of the nature of this product is structured, the investor have limited upside but unlimited downside in theory. If the 4 market (Singapore, Malaysia, Thailand, Taiwan) close above the inital price of say 100 (this is just a price I use for illustration) immediately in the first quarter, investor only received the 7.5% p.a., i.e., $1,875 for 1 payment, and the bank than redeem the note.

Therefore, the only way for the investor to receive the full number of cipon payment if for the 4 market indices to trade below the initial price for the next 2.5 years. However, you do not want the market to trade too low to have the triggered event kicks in, if that is the case, you have a possibility of losing your capital. Remember that the triggered event is if any of the 4 indicies close below 50% of the initial price. If this is to happen, what is the chance of it rebound above the inital price before the 2.5 years is up? Say the Thailand market fell 50% after 1 year, thus the triggered event kicks in, and you must than hope that the Thailand market can rebound 100% in the next 1.5 years so that you will not loss money, quite an unlikely event.

Furthemore, the way it is structured, it is a "diversification in reverse". If you put money into the 4 market, you hope to diversify, in case any one market tank badly, you will not be affected that badly. However, in this structure, any one market tank will drag your whole porfolio down since it is basked on any one market that fell 50%. Therefore, if say Thailand market is affected by its political situation and tanked 50%, even if other market make 100%, 200% or 300%, it does not matter, you will not make a single dime because of the Thailand market.

In my view, this product is good if you think that the market will at least go lower and remain low for awhile, but not too low to let the triggered event kicks in. market may consolidate for a while, but it is unlikely that it will remain within a range for 2.5 years.

So do not expect to get 7.5% p.a. for the full 2.5 years, chances are that if market recovers, this structured notes will get redeemed sooner rather than later.

As an aside, this product looks like the investor is selling a call optionon the 4 market at the initial price of 100, and at the same time, also sell a put of the 4 market at the initial price of 100, but with a knock-in at 50% below the intial price, i.e., at 50.

The (Whole) Truth about Trading Performance

I bump into my friend this morning while having breakfast. She is now working in a local bank as a private banker.

We had some small talk, and I mentioned to her that I am doing some trading on the side, and if things work out smoothly, than within the next 2-3 years, the income that I generate from my trading should be about the same or even exceed my pay. She is curious if I will just quit my job and do trading for full time.

I told her that it depends if I am happy at that time with my company and boss. If I am happy (or at least able to take the nonsense from my boss), than I just stay put. At the end of the day, I am like getting paid 2 salary (one from my normal job, and another from my trading). Moreover, I developed a trading methodoloy where by it does not depend on the direction of the market, which somebody call this market-neutral trading. The good thing is that it requires very little attention from my part, the bad thing is that I will not be able to generate super normal profit (hey, you need to give and take). But if I can make it, than at least I have a choice, and to me, such choice is very important in this day and age whereby you do not know when you will be axe...

From my friend's expression, she is as if asking me what sort of return I am making. I told her that I started trakking the performance from Jul 2007. I benchmark my performance against the exchange traded fund SPY (this is an exchange traded fun that track the performance of the S&P 500). Since Jul 2007, SPY return is -5.54%, while my trading performance is +11.67%, thereby outperforming the SPY by 17.21%.

My cumulative return on a month-to-month basis is as follow :

Date SPY S&P Return Fund Return
7/31/2007 145.72 (SPY) (in USD)
8/31/2007 147.19 1.01% -4.52%
9/30/2007 152.58 4.71% -3.04%
10/31/2007 154.65 6.13% -1.10%
11/30/2007 148.66 2.02% 0.64%
12/31/2007 147.10 0.95% 1.36%
1/31/2008 137.37 -5.73% 1.12%
2/29/2008 133.82 -8.17% 6.32%
3/31/2008 131.97 -9.44% 5.32%
4/30/2008 138.26 -5.12% 7.09%
5/23/2008 137.64 -5.54% 11.67%

My trading performance seems to be very good compared with a passive buy-and-hold strategy (compared with buying the index fund of SPY, whereby the return is -5.54%), however, I told my friend this is infact a little misleading. The reason is that before Jul 2007, I have been losing money. I gone through a period of trial and error, research etc. to find a trading method that is suitable for me, and only than I started to turn in some profit.

And this bring me to my topic today.

As one can see from above, my trading underperform from Aug to Nov, but outperform from Dec to May. If I want to mislead people, I will simply show people my trading performance from Dec onwards.

Many times, one read from the papers about courses that teach readers how to trade FX or options, and the advertisements are full of testimonials from students that make tons of money. Is that the truth? The Straits Times wrote an article 1-2 months back. One reader wrote in to the forum and said that his friends lost alot of money. So why the difference?

I think the answers are as follow :

1) the advertisement told the truth, but not the whole truth.

For example, in an advertisement of option trading, the student claim that he made 1000%. While I have no doubt that this is true, however, that trade may be the ONLY trade that he make money. That is to say, he can be making 20, 30, 50 trade, but only one trade happen to make 1000%, and overall he still lose money.

Another possibility is that the student just buy a very cheap option, like $0.10 per contract before the earnings result. It happen that on that particular quarter, the results beat expectation by a wide margin, and the stock price went up. The option than jumped from $0.10 to $1.00. The result is that the student make 1000%, but in absolute term, only make $0.90!

So what's the point, you may ask, for making 1000%, when in absolute term he only make $0.90 (or $90 per contract)?. This has to do with the "Option Competition" organised by the trainer. The trainer organised an option trading competition, and will give out awards to student that make the most in term of percentage gain. In order to "make it", students can make many small bets by buying very cheap option, like the $0.10 option. If the trade gone wrong, he loss $0.10 (or $10 per contract), but if things gone right, he can boast about the 1000% gain.

2) unrealistic expectation.

One must realised that trading is just like any other profession, to be good at it, you need constant learning and practise to improve your skill. A doctor taks 6 years of medical school to get to where he is, ditto for dentist, architect etc, so what makes one think that he can master trading just within a 3-4 day seminar?

3) the trainer himself is questionable.

Will you want to learn from Warren Buffett (the richest man who make his money fromm investing), or will you want to learn from a Mr. Tan Ai Kou who you have never heard before? The answer is obvious. However, there are many traders out there that can and had make their money, but is not as well known as Warren Buffett, so the only way to be sure is to ask them for their trading account. If he can produce his trading account and show that he can consistantly make money in the past, than you will be more comfortable learning from him. One should ask for the statement for at least 18 months to be certain, if not, the trainer can simply show you a very short period of time that he happen to make money (like if I only show others my "track record" from Dec to May).

4) Failed to understand own personality and style.

There are many trainers out there that are true trader that make their money. unfortunately, their methd f trading may not be suitable for you. Take an extreme example. Warren Buffet is well known for his buy and hold style. He identify solid companies and hold it for years and decade. Now, if one day, Warren Buffett knock on your door and offer to teach you everything he know, will you become Warren Buffett the second? if you are one of those that itch for action and are impatient, you cannot even hold the stock for 3 days, not to say 3 months or 3 years. Than you will end up making losses eveytime the market is against you and you just get out of your position. The stock may ultimately goes up, but you are not there to take advantage already. Warren Buffett's method work-- for him, but unfortuantely, it does not work for you.

Capital Protected Note in EUR

Last month, my boss gave me a note. The note outlined a structured product call Capital Protected Note (CPN). My boss was very excited over the product and asked me what I think.

The CPN works like this :

"The CPN enables you to participate in the positive development of an equally weighted currency basket composed of a selection of 5 emerging currencies (BRL, RUB, IDR, INR, ARS) against USD while remaining invested in EUR."

If the basket of currency falls, you get 101.50% of your capital upon maturity. If it appreciates, you get 117%.

Once I saw such structure, I immediately know that the bank is trying to rip the customers off. The bank do it by several ways, but before I get to that, I need to break down the components of the structure.

1) The bank take your EUR which has a higher interest rates compared to the USD. They than hedge it buy doing a currency swap, whereby the interest rate differential is in their favor. In this way, no risk of the EUR/USD exchange rate is hedged and therefore there is no risk for the bank. They than tell the customer that the customer can invest in EUR without any EUR/USD risk, which in actual fact, the customer lost out!. The estimated lost to the customer is about 0.50% on this component.

2) The bank than go and buy what we call a "basket option" of the 5 currencies. Specifically, the bank buys a USD put against the 5 currencies. A basket option is cheaper than if the bank were to buy USD put against each individual currency because as a basket, there is diversification and offsetting of the volatility. The is the second component that the bank rip customer of without telling them.

3) Because the USD interest rate is very low and the basket currencies are of high interest rate currencies, the USD put is very cheap. So what the bank does is to take the customers' money, use a small portion to buy option, and than invest the balance into instrument like FD or T-Bills. The yield from FD and T-Bills will be more than enough to cover the cost of the option and thus making the structure "capital protected". The bank than charge a "management fee" of 1%.

The customer, like my boss, were trailed by such products because they do not understand how it was structures and how it can be done cheaply by themselves.

However, I feel very sad after I showed my boss how we can structured the same product at a lower cost and also avoiding paying the bank 1% management fee. My boss, who is initially very excited with the product, lost interest just because I show him I can structured it. He must be thinking if I can structured it, than the product must be not very complex and thus do not want to invest in such simple product.




1)

Dual Currency Deposit

My ex-colleague told me the other time that she just placed a dual currency deposit whereby she get a higher interest rate compared with a normal SGD fixed deposit. She asked for my view on this instrument. She is a little concerned after her colleague, who is a treasury manager working with her, told her that it is a risky investment.

To understand if this is a risky instrument, I told her that she need to understand how does it work. In a dual currency deposit as for her case, she has SGD and thus SGD is her base currency, and AUD is her alternate currency. By placing her SGD into a dual currency deposit, effectively she is selling a “put” option – an AUD put, to be specific against SGD. In return for this option that she sold, the bank “compensate” her by giving her a higher interest rate for her SGD deposit. Therefore, if the strike is at say 1.2500, and upon expiry if the AUDSGD rate goes below 1.2500 to say 1.2000, she will take delivery of the AUD at the rate of 1.2500, instead of being able to buy AUD at 1.2000 (which is cheaper). The question is than whether she thinks that the AUDSGD rate will be above 1.2500 when the deposit mature.

From the looks of it, I told her that the AUD will likely to strengthening against the SGD and thus she need not be overly concerned.

So as far as investor is concern, such instrument can enhance the yield because investor is selling a naked put option to the bank. As long as the investor understands what the dual currency deposit comprise of and the directional view of the currency pair, it is not as risky an instrument.

For me, I am more particular about the pricing of the product. The bank always priced this type of product in order to rip of the customers. So I went to a bank to ask them for a quotation for a dual currency deposit on NZD against USD to see how much the bank rip the customers off, and this is what I found:

Current spot NZD/USD: 0.7835
USD interest rate for 1 month: 16.5%
Strike: 0.7785
So you receive USD14,208.33 if you deposit USD1 million in the structure.

I than check the inter-bank rate for the option pricing for NZDUSD, and it is as follow:




As you can see, the premium for the option is 1.5687%. That is to say, if you sell a NZD put against the USD for USD1 million for 1 month, you can receive USD15,686.99. On top of that, you still have your USD sitting in the bank, and assuming you set aside USD100,000 as margin, your balance of USD900,000 should earn you interest. At a rate of say 4.5% for 1 month, it can earn you USD3,487.50.

Therefore, all in all, if you sell naked put option on the NZD put on margin, you can achieved the same risk payoff at a cheaper price. How much cheaper? Well, through the selling of naked put option plus the deposit, you received a total of USD19,174.49. The bank pays you USD14,208.33, and the difference is USD4,966.16.
on top of that, because the bank quoted me a spot NZDUSD rate which is 20 pips away from the interbank spot rate, that will cost me another USD2,000. So all in all, it is about USD6,966.16.

Of course, I am basing on USD1 million. If you work out base on USD100,000 it will be about 10% of it.

STI update - Part 4

The STI moved up nicely. On Friday, it traded higher but closed the day at the low, forming a "doji". This is bearish in nature. From the trend line, it traded above the up trend line. This is term a "throw over". The whole up move from August 2007 looks like a rising wedge to me and thus I view this as a correction.

I stick to myview that the up move in the STI is a correction within a correction, and thus I expect the STI to have another leg down towards the 2800-3000 level.

Why isn't the SGD as strong as what the media make out to be?

I have this strange feeling, although this is at odds with what we are know.

We were being told by the media that how strong the Singapore economy were and how strong the Singapore currency (SGD) were, and how strong the stock market (STI) were. However, when I went back and check the SGD exchange rate with other currencies including EUR, GBP, CHF, THB, IDR, CAD, AUD, NZD, JPY and USD, the SGD in the past 10 years only strengthen against the USD, JPY and IDR. In fact, if we were to discard the period of weakness from 1997-1998 for the IDR, SGD has in fact gone nowhere against the IDR!

So if our economy is doing that well, why our currency is weakening against others? This is really at odds with my understanding. The reason is, therefore, our economy is not as good as it is. True that the STI is making new high. But that is so only because it measured in SGD term. If we measure it in term of say EUR, the gain is only just maybe 3%, and measured against gold, it in fact decreased! What happen? To put it simply, our purchasing power is eroded, and if you happen to be the less well off or less educated and did not put your money into equity or property market, you will loss out.

I ponder what is installed for us going forward. I looked at the CHF against SGD and to me, it is clearly bottoming out. It means that the SGD will weaken against the CHF going forward. In fact, I foresee SGD weakening going forward. And because of the weakening of the SGD, the STI may scale new high, but that is nothing to shout about because it merely reflects the weakness of the SGD. The central bank can simply print money to jack the stock market higher, but if you measured it against hard currencies like gold, you will find that the stock market measured in term of gold will fall dramatically.

What is the implication? This implies that the gap between the have and have not will widen.

I am not very optimistic about the future of Singapore. Despite what the government paint about a picture perfect scenario, I think their policies are just benefiting the rich.

With the Indonesia government reviving their plan to build a nuclear plant near a volcano, and natural disaster will have a huge impact. According to Australia National University (ANU), its study suggested that if there is a nuclear plant accident, the leak of the radiation can cover as wide as from Southern Thailand to Northern Australia, effectively wiping out whole of Singapore. So why isn’t our government doing anything about it? Or is it that they think that nothing can be done? If that is the case, I am not surprise that we will see our minister starts to migrate in the next decade (and maybe this explain why they wanted the pay hike).

Compulsory Annuity Scheme is a bad idea

The compulsory annuity program that the government is thinking of is not a good idea in my opinion. This is simply because I believe by setting aside the money in a saving account for the members will be more feasible and better, as this will allow them to have their money return to them should they fail to live beyond age 85.

I did a quick calculation based on my understanding of the scheme:

1) Assuming that a sum is set aside at age 55, and can only start to withdraw at age 85.
2) Assuming that one live till 100 years old (which is highly unlikely, but for argument sake)
3) Assuming the scheme is to let one withdraw $300 per month.
4) Also assuming an interest rate of 4% (which is the current Special account interest rate)

With the above assumptions, we can calculate the Present value (PV) of the sum required to have for one in age 85. The PV is $40,558.

To achieve an amount of $40,558 from the time a member withdraw his money in age 55 to the age 85 is a thirty-year period. Therefore, by setting aside $12,505 at the age of 55 and compounded it at 4% over 30 years, one can easily meet the objective of having $300 per month.

The good thing about this saving scheme is that the member need not worry about whether he can live beyond 85 as it is just a saving scheme and upon his death, any outstanding sum can be returned to his family member.

I urge the government to consider this alternative instead.

STI update - Part III

I written about a month or so ago that I expect STI, after breaking the uptrend line, to trade higher to "kiss" the trend line before it fall. The market play out exactly to my script. Than I mentioned in part II that I expect the STI to find support only around 3000-3200 level. The market hit around 2960 level and rebounded.

So the question is where it is heading to now. I expect STI to trade in a range first. It will eventualy trade lower to retest the low of around 2960 or exceed it by a little to around 2800. There is where I think STI will botom out. Of course, whether it will reach there or not is anyone guess, but if STI ever goes to around those level, I think it is a good time to enter the market.

Heading to Japan for holiday

After about 1.5 years since my last holiday, I am taking my break. And this time round, will be going to Japan again (this will be my sixth time visiting Japan). Below is a video by Hiromi Iwasaki, one of the singers I like alot.

An update on the USD index

A few weeks ago, I asked the question whether has the USD turned. The USD index broke up the downtrend resistance line, and now it falss back to retest that line.

It is quite common for any instrument to do the above. With the fear now in the market that the USD may collapse, this may be the real turning point for the USD.