Halifax Houses Market Data

We have in the last 4 years been involved in buying Nova Scotia real estate and we’ve had to analyse the market to look for criteria we wanted. However we found the real estate broker websites in the Nova Scotia area generally did not good market overviews like absorption weeks and overall property inventory numbers.Therefore we felt we need to write our own Halifax Houses Market Data tool to quickly visualise and compare market trends.

The previous Real Estate Market Data Visualisation Tool was written about 3 years ago for locating individual properties for potential purchases. Now that we have some properties, the new Halifax Houses Market Data tool was developed in 2019. This new tool is for reviewing general trends and market analysis, so we can monitor the existing property investments.

So how do you use Halifax Houses Market Data tool ?

The tool instructions are relatively straightforward:

Halifax Houses Market Data tool - Halifax Nova Scotia - Instructions - 20191010

1. Select vertical axis with one of the many market data variables available.
2. Optionally select the horizontal axis with a market data variables, but for most cases it is simply better to maintain “Statistics Date” settings to get a time based chart. If you want to do scatter plot to see data correlations between two variables, then it can be useful to select something other than “Statistics Date” for the horizontal axis. However generally maintaining “Statistics Date” is better to keep a time series.
3. Move mouse over chart data points – left hand side is 2011 and right hand side is now. A tooltip popup will give you the “Statistics Date” for that data point. The vertical axis gives the value ranges for the selected market data variable and the actual value is given below in the market data pane (beneath the select boxes). The chart always plots the selected vertical market data variable against the selected horizontal market data variable.
4. View the market data pane to see all variables for that date. The market data view changes dynamically as mouse moves over different chart data points. Each data point on the chart represent a date has all the market data variables that appear in the market data pane. The two selected axis variables are highlighted on the market data, so it can be easily seen what is selected when moving the mouse over the chart data points.
5. Repeat from point 1 for different market data variables.

The tool can be quickly used to identify long term yearly trends in the market, hopefully to predict best times to buy and estimate future market direction.

Low absorption rate

Absorption rate is the amount of time it would take for all open listings to be purchased (assuming no further listing were added). The absorption rate calculation here is defined as the total number of available homes divided the average number of sales per week. The absorption rate is a number of weeks, specifically the number of weeks it would take for all current housing inventory to be exhausted.

This screenshot shows how the market absorption rate (in weeks) typically moves in a predictable seasonal range with lows in the summer (less houses available) and highs in the winter (more houses available).

Halifax Houses Market Data tool - Halifax Nova Scotia - Absorption Rate Weeks - 20191010

From 2012 to approximately end of 2016 absorption rate went with seasonal moves, from average lows of about 40 weeks, to winter highs of on average about 60 weeks. This pattern repeated each winter from 2012 to 2016, even though there were some 2014 data points with some very significant highs around 100 weeks. Some of the 2014 data points maybe “bad” data points, but the take away is that there was a huge amount of unsold inventory on the market at the time.

However at the end of 2016 absorption rate started a downward trend that is still continuing. The absorption rate has declined with usual seasonal patterns, but importantly seems to be trending lower every year. This would indicate that market conditions are a lot tighter now, with a houses being purchased quicker so that it reduces available market inventory. A faster absorption rate often reduces the amount of quality houses for a buyer, simply because the demand picks off the better priced deals first. From a final high of 65 weeks at the end of 2016 the absorption rate has declined to a low of 17 weeks in Oct 2019. To put this another way – Halifax housing inventory would be exhausted 3 times as quickly in 2019 compared to only 3 years ago. This implies a significant move from a buyers market to a sellers market.

Active Listing for Single Family

Halifax houses market data has been separated into a single family category (removing condos and vacant land) because that is our target property for rentals. This can include multi family up to four units. This deliberately excludes condos, because on average the monthly charges on condos make then inefficient rentals.

The screenshot below shows the number of active listings for single family homes from 2011 to now.

Halifax Houses Market Data tool - Halifax Nova Scotia - Listing Active Total Singlefamily - 20191010

The number of active listing for single family homes has peaked from a high of approx 4,000 in mid 2015 to a low of approx 1,500 in Oct 2019. This would indicate that market conditions are a lot tighter now, with a reduced amount of single family houses to choose from. Similar to absorption rate, this implies a sellers market in Oct 2019.

Data Integrity

Most variables are available from approximately July 2011 to present dates. Some data points for some variables are missing from 2011 to approximately 2013, so there maybe incomplete data points with blank chart data points during those time ranges. Occasionally data points are obvious outliers that can be ignored if they appear way below or above the usual chart curve. The aim of the tool is to look for trends, not get the data absolutely perfect.

Emerging Markets Iron Condor

This is another bread and butter trade with an emerging markets iron condor, going out a bit further in time to October with 78 days to expiration (DTE). Emerging Markets ETF EEM has sold off rapidly due to market tariff and rate cut talk this week, which has provided inflated volatiliy. This is a limited risk range bound trade for EEM with the expectation that the market maintains its position over the next two months and that volatility contracts.

Trade entry Emerging Markets Iron Condor

Here is the trade entry for EEM iron condor:

Contracts  Expiry Date  Strike   Price   Amount   Trade
-------------------------------------------------------------
+5         Oct 18 2019  45.00  C $0.05   $ 52.69  Buy to Open
-5         Oct 18 2019  42.00  C $0.74  -$372.25  Sell to Open
-5         Oct 18 2019  38.50  P $0.76  -$317.20  Sell to Open
+5         Oct 18 2019  35.50  P $0.35   $122.79  Buy to Open
-------------------------------------------------------------
Total    	                        -$513.97 (credit)

On trade entry on 2nd August there were 78 Days to expiration DTE through to option expiration on 18th Oct. According to the 30 day rule this means that can consider exiting the trade on or after 2nd Sept. On 2nd Sept this would still leave approximately 48 calendar DTE, so there is plenty of time to adjust or exit. The following table sounds the future trade lifecycle dates when trade exit or trade adjustments could be optionally applied:

Trade Lifecycle for EEM Iron Condor

Trade Date
Trade Lifecycle (Optional)
Days to Expiration
(DTE)
2nd August 2019Trade Entry - enter Iron Condor according to original trade above78
2nd September 2019(Trade Exit) - optional earliest possible date for a full trade exit according to 30 day rule.48 to 1
13th September 2019(Trade Adjustment) - latest possible date to do a trade adjustment using the same Oct options (trade adjustments must be at least 30 DTE)78 to 30
18th October 2019Trade Exit - latest possible date to exit original Iron Condor with any optional trade adjustments that were added.1
Note: Trade Lifecycle actions that are optional are in brackets like this (Trade Adjustment) or (Trade Exit).



The option deltas sold on each side are approximately 35% on the call and 25% on the put, so there is approximately a 70% chance that the call will be touched, and a 50% chance that the put will be touched anytime between now and Oct expiration. Therefore it is likely that the short options at $42 and $38.5 will be tested at some point on this trade, but it can be held due to the limited risk. The breakeven points of $43 and $37.5 are at the high and low ends respectively of the trading range price action for the last year, so we can be reasonably confident that at some point in the next couple of months EEM could return to the the middle of this range – even if there is likely to be some short term volatility, possibly with the short options being touched.

Trade Summary

The aim will be to close the trade for a $100 to $250 profit after 30 calendar days have elapsed, but this could require being patient and waiting for volatility to come in a bit and the trade to move back into the middle of the range around the $40 mark.

Mexican Bearish Put Butterfly

This trade idea is a trade adjustment to a currently open bearish trade on the Mexican Market ETF (EWW). The strategy ultimately converts the existing bearish diagonal spread into a bearish Put Butterfly.

Trade Update for 30 July 2019

A trading update on July 30, 2019 shows that the ETF has brought the speaking been in a range for the majority of the month around the $42 mark. However with the federal reserve rate cut announcement there was a drop off on the afternoon of 30 July that has caused for the ETF to move down beneath the $42 strike in August. This means that the August short put is now ITM and needs to be managed accordingly however this is being fully offset by the $43 port in the September cycle. The aim here would be to maintain the position slightly closer to expiration to allow any time premium to drain out of the August cycle, and then either close the position or do a short put roll into September.

The rolling options are to either roll the $40 put into either a $41 or lower put to maintain the bearish position into Sept 2019. Alternatively the put could be rolled to create a September butterfly by selling twice as many puts and adding a down side put for protection. This would create a butterfly that can be held into September expiration. Ideally this would be done into a higher volatility environment to get as much juice as possible into the September options.

Long Mexican EWW Bearish Put Diagonal Calendar Spread - Trade Update Chart - 20190731

The position has approximately $120 profit and long as the etf stays under the $42 level this profit is not at risk. The 30 day calendar period has elapsed so the position can be closed or adjusted anytime. Therefore position can be maintained for a few extra trading days and monitored for a good Time to roll into September once even more time value has drained out of the August short put. Currently there is still approximately $0.50 time value (or about $300) left in the August short put, so this is a potential time profit that can still be extracted from the position.
Ultimately no adjustment was done today.

Trade Update for 1 August 2019

On 1st August 2019 in afternoon trading the Trump administration announced more tariffs against China. This somewhat spooked the markets triggering a fairly swift sell off in markets especially those effected by tariffs. This meant that the August short put at $42 has gone significantly ITM. With Mexican ETF EWW trading at approximately $40.75 the put had only about $0.20 extrinsic value, so it was a good candidate for rolling.

The sell off generated increased volatility in a short amount of time and ATM put premium in September looks quite attractive to roll into. This was an opportunistic trade due to the swift selloff, so the decision was taken to convert the position to buy September butterfly.

The August $42 put was brought back (buy to close) for a $450.71 loss, and was replaced with 12 contracts of $41 puts sold to open in September, followed by 6 contracts of $39 puts bought to open. The existing $43 put in September was maintained and not changed as part of the position. This converted the entire position into a $43/$41/$39 September butterfly. The entire new position result in a $288.67 credit, so the most that can be lost on the trade is now -$450.71 (from the losing $42 august option roll) plus the $288.67 credit received for Sept butterfly – so max position risk is now only $162.04. This roll was all completed in one trade ticket with one set of commissions.

This table gives the new position below. The top two options rows are option roll described above. The last option row is not a new position, but simply maintaining the original long $43 put from the original trade entry.

 
Trade Date
Category
Trans Type
Description
Symbol
Quantity
Price
Amount
01-Aug-2019
Income
Buy to Open Long Put
Put  EWW  39.00 EXP 20-Sept-2019
EWW190920P39.0
6.0
0.66
-$393.35

01-Aug-2019
Income
Sell to Open Short Put
Put EWW  41.00 EXP 20-Sep-2019
EWW190920P41.0
-12.0
1.33
$1,596.32

01-Aug-2019
Income
Buy to Open Long Put
Put EWW  43.00 EXP 20-Sep-2019
EWW190920P43.0
6.0
1.52
-$914.30

TOTAL
-$288.67

 

This roll exchanged approximately $0.20 of time value in the August cycle for approximately $2.00 time value remaining in the September cycle. If there is a large move either way over for example $43 or $39 then the maximum amount will likely be lost. The optimum trade scenario would be to close around $41 at September expiration. Because the trade is a butterfly trade it will benefit from a decrease in volatility and from the waiting until expiration. Given the low risk in this trade it would be fine to wait until very close to September expiration. Even if Mexican ETF EWW moves around a lot there will likely not a significant profit/loss changes until closer to expiration.

Summary of Mexican bearish put diagonal spread (converted to butterfly)

The Mexican ETF EWW will likely be volatile over the next week or two and may well move outside the ideally trading range of $39 to $43. But the approximate $41 target for September is on the low-end of the historical trading range for the last six months (a historical support line) so it is possible that becomes resistance with a move down in August and subsequent rally back up in September. However the trade will be held and re-evaluated in 30 calendar days - basically a low risk trade waiting for lower volatility and getting closer to September expiration.

Trading Gold Long Term Diagonal Spreads

This trade idea shows how to approach trading gold with long term diagonal spreads. The trade example shows how a bullish multi month GLD long call diagonal spread was entered and managed. This trade was IRA eligible so using multiple option legs does not generate lots of complex tax reporting, and there was no issue of paying extra capital gains if the trade is ultimately successful.

Gold market and GLD volatility overview

In March 2019 FED was signaling a rate pause which could be bullish for gold prices. This is an example of using options to express a “long gold” opinion in a portfolio, in this case using the physical Gold precious metal ETF (GLD)

In March 2019 Gold volatility was approximately 9%, which was in the lower quartile (lowest 25%) for the last six months – having had a range of approximately 12% in Dec 2018, down to 8.5% in Feb 2019. Low volatility generally makes a better trade entry for long term calendar diagonal spreads. Importantly saying that “the volatility is cheap” only means relative to its own recent history in the last few months for this particular ETF or commodity. This does not mean that the underlying will not move around, because trading gold is historical volatile. This only means that the debit on trade entry is cheaper, simply as you don’t pay as much option time premium for the longer dated call (because the market is currently pricing less of an expected move by Sept 2019).
The chart below shows the GLD volatility chart for several months before and after trade entry on 22nd March 2019.

GLD July 2019 1 year volatility chart
trading gold - Long GLD Diagonal Calendar Spread - Volatility chart with Popup Balloon - 20190729

Trade Entry in March 2019

Having made a decision to long gold for 2019, the next step is to structure a suitable risk/reward trade within the 30 day rule. Here is the original trade entry when GLD closed at $123.97 on 22nd March 2019:

 
Trade Date
Category
Trans Type
Description
Symbol
Quantity
Price
Amount
22-Mar-2019
Portfolio
Sell to Open Short Call
Call GLD 128.00  EXP 17-May-2019
GLD190517C128
-6.0
0.77
$464.65

22-Mar-2019
Portfolio
Buy to Open Long Call
Call GLD 128.00  EXP 20-Sep-2019
GLD190920C128
6.0
2.70
-$1,622.29

TOTAL
$ 1157.64

 

This trade was OTM so had approximately a 30% of being ITM at expiration - it was therefore a lower probability trade, but high conviction portfolio position ("long gold for next 6 months"). Losing the entire trade premium (defined at trade entry) was acceptable risk for the overall portfolio - but the payoff was potentially large for the relatively small initial risk, so it created the right risk profile to express the trade idea. Initially selling the shorter dated call help finance the longer dated call, and reduce the overall risk in the position. The intent is to avoid this shorter call being assigned and roll it multiple times over the summer to gradually chip away at the premium paid for the longer dated call.

Here are the main high level scenarios for the trade outcome - GLD stays in a range, goes up a lot or goes down a lot (just about covered all scenarios in finance there!):

If gold stays the same or rallies slightly towards but not through the short call, it can likely be bought back for less than it was sold for - this helps to reduce the basis on the original longer dated option. If this can be done over a few months rolling option calls can nicely reduce the basis on the original longer dated option. Usually selling the 30 delta OTM call is a decent starting strategy initially, but once the position basis is reduced then selling calls that are more than 30 delta OTM is ok.

If gold rallies strongly in the next month, it maybe difficult to roll the short call at a profit. This is a risk of the calendar spread strategy - the market call is "right" but gold rallies too fast, and the position makes little money. This happens because the negative delta of the short call becomes similar to the positive delta of the longer dated call - so the overall position can become delta neutral or even negative delta (short underlying) in a strong rally. On average though the short call can be managed with month to month adjustments.

If gold tanks in the next month, it maybe difficult to roll the short call to get any reasonable premium in the same strike in the next month. However if any premium is available in the next month call, then it can be sold at the same strike. In the situation where gold goes down, one luxury of any calendar spread strategy is to simply sit on the trade and hope it comes back. This is "ok" as a strategy with calendar spreads because the limited risk was defined at order entry.

Trade Adjustment in May 2019

The trade adjustment that was chosen in the end, was to let short call expire worthless and simply hold the longer dated Sept 2019 call option. This has keeps the trade risk to approximately $1150 but there is still now no upside cap and still plenty of time for the trade thesis to play out. The trade is now $464 better off than if we had just bought the long dated call for $1622. Sometimes doing nothing can be the best option.

Option Skew in July 2019

As of 29th July, the Sept 2019 Option premiums are indicating that the market is pricing in significantly more upside than downside for gold in the next 7 weeks. Looking at the option chain below shows the distance of both 30 delta OTM put and call options from the underlying GLD price.
trading gold - Long GLD Diagonal Calendar Spread - Option Chain Skew Sept 2019 - 20190729

GLD is traded at $134.53 as of the NY close on 29th July 2019. Going 53 days to expiration on the Sept 2019 option chain, shows that the $139 call (with a delta of 0.2998) has approximately the same delta of the $132 put (with a delta of 0.2963). This means that market is assigning the 30% probability that GLD is $4.50 higher by Sept 20th 2019 expiration and a 30% probability that is $2.50 lower. That appears to be a huge bullish skew indicating that the market is still expecting higher prices in the medium term - despite the recent rally. If that bullish skew starts to disappear in the next few days, then would consider closing the long position, but for now content to hold until closer to expiration - especially because the option position only has a relatively small amount of remaining extrinsic value (time premium).

Specifically the extrinsic value (time premium) on our long dated call option is only approximately $0.65, with the majority being intrinsic value. Extrinsic value was calculated by adding the mean bid/ask for the option price ($7.175) to the option strike ($128), then subtracting the actual GLD market price ($134.53) = approximately $0.645.

Importantly this now means that the option delta is over 90%, so the position is trading like a stock position in the underlying. Since 6 calls $128 Sept 2019 are held, that representing a 6 x 100 x option delta = 600 shares x 0.9088 position = approximately equivalent to a 545 GLD share position. That represents a notional position of approximately 545 share equivalent x $134.53 = $73,318. There are some slippage in option bid/ask spreads and the option will move as GLD moves around - but that does give a good approximation of the current position size.

Trade Update in July 2019

This is the current GLD price as of 29th July 2019, and the position has made nice progress after the trade entry on 22nd March 2019:
trading gold - Long GLD Diagonal Calendar Spread - Price chart - 20190729

The current unrealised gain loss on the Sept 2019 call position $2727, added to the $454 from May 2019 expired call, gives a total gain for the overall position of approximately $3181. This is approximately a 276% return on capital so far.

These are some possible exit strategies as the option call is getting closer to Sept 20th 2019 expiration date:

Exit long dated call at a profit - simplest technique, but does not maintain any portfolio gold exposure which will likely be a good idea in a rate lowering environment. This can be done by either just simply selling the call, or by selling dated Sept 2018 ATM calls and hoping to deliberately get called away.

Roll long dated call up and out to a higher strike - this will depend if volatility is still high (over 10%) then this would be an expensive trade. Specifically because if the long option is significantly ITM and getting closer to expiration date (Sept 2019) - it will not have a lot of time premium left in it. Rolling the call up to several months out further out will likely incur some higher than desired premium (due to the high volatility environment). However rolling out could remove all risk from the position (if done for a $1150 credit) and would maintain a multi month GLD position into 2020.

Sell long date call, and switch to using "high volatility" strategy to maintain a long gold position - e.g. bull put spread

Summary of trading gold with long term diagonal spreads

In summary on 29th July the call option position represents an equivalent $73,318 long GLD position, that was acquired with about $1150 of risk. With this strategy there was initially a 30% chance of GLD finishing in the money above $128 by expiration (based on the option delta). The probability of a touch is defined as double the initial option delta - so that also means that over the trade lifecycle there is a approximately a 60% probability of GLD touching $128. To word that in a different way it means that at some point between Mar and Sept 2019 in all likelihood there will be about a 60% possibility of taking at least some profit from the trade. Additionally because we thought GLD would go up in 2019, then we also are thinking that the stated probability was under priced. That meant that using our bullish opinion on trading gold from the macro fundamentals has given us the opportunity to put the odds on our side.

Importantly this wasn't just like a lottery ticket style infomercial that says "I make 500% a week buying options" - where the stated returns are often from buying lottery ticket way OTM options that only make that "big" money occasionally, but on average is a losing option strategy. In summary the GLD strategy had:

  • a defined theoretical probability in advance
  • limited risk/reward
  • time for the investment idea to play out

This trade shows the power of option leverage, and why it is always a good idea to structure your portfolio to respect it - even if we just happen to be on the right side of it this time. This trade is still ongoing so no decision has been made yet, however it shows how to get to good risk adjusted returns using a relatively small amount of capital.

Mexican Bearish Put Diagonal Spread

This trade idea shows how to approach trading the Mexican Market ETF (EWW) with a slightly bearish bias. If EWW maintains its position or goes down slightly over the next month, then this position is likely a winner. The strategy will only make a limited amount of money if a large sustained selloff occurs immediately. The only main directional risk to the trade is a large rally higher. This trade was IRA eligible so using multiple option legs does not generate lots of complex tax reporting, and there was no issue of paying extra capital gains if the trade is ultimately successful.

Mexican market and volatility overview

Mexico has been in the news recently due to a lot of tariff talk. This has meant that the Mexican stock market has been trending down since April 2019. EWW has had a high of $47.18 in April 2019 and a low of $41.77 in March 2019. For the majority of 2019 the ETF has been in this trading range between approximately $42 and $47. This relatively confined range and lower volatility makes it a good candidate for a diagonal spread. The trend since April 2019 has been slow ping gradually down so rather than buck the trend we can enter a slightly bearish put calendar spread to take advantage of any ongoing minor sell off.

Mexican Bearish Put Diagonal Spread- Trade Entry Chart - 20190628

The volatility chart for the last year shows a very wide range of implied volatility there was a huge spike up to approximately 43% in December 2018 when the tarriff talk was at its height. They implied volatility has moved down a lot since then six months later and by the end of June 2019 is approximately 18% which is one of the lowest readings for the year. Therefore it is a good relative volatility level to enter a put diagonal spread that will benefit if volatility increases. We can continue to express a slightly bearish opinion without over paying on trade entry for option premium.

Short EWW Bearish Put Diagonal Calendar Spread - Volatility chart - 20190628

Mexican ETF Trade Entry in June 2019

The trade entry was on 28th of June 2019 as shown in the trade below:

 
Trade Date
Category
Trans Type
Description
Symbol
Quantity
Price
Amount
28-Jun-2019
Income
Buy to Open Long Put
Put EWW 39.00  EXP 20-Sep-2019
EWW190816P42
-6.0
0.72
$434.64

28-Jun-2019
Income
Buy to Open Long Call
Call EWW 43.00  EXP 20-Sep-2019
EWW190920P43
6.0
1.52
-$914.30

TOTAL
$ 479.66

 

Summary of Mexican bearish put diagonal spread

This trade was OTM so had approximately a 40% of being ITM at expiration - it was therefore a lower probability trade. Initially selling the shorter dated put help finance the longer dated put, and reduce the overall risk in the position. The Mexican ETF EWW will hopefully drift lower over July without any major move either way.

Futures Calendar Spreads on Interactive Brokers

Trading futures calendar spreads is a good way to express a long or short opinion an underlying index or commodity, without the volatility and margin requirements of a fully directional naked future contract. We are using Interactive Brokers (IB) to trade future calendar spreads, but many other future brokers offer this. Here we can review an example Natural Gas /NG bullish calendar spread, that should benefit from a rise in the commodity price. This bull future spread means long a front month future contract, and short a back month future contract.

To describe trade entry and exit on this bull future spread we will use the IB “buy” and “sell” terminology as follows:
Trade entry – means to “sell” the spread (go long front month, then short back month)
Trade exit – means to “buy” the spread (short front month and go long back month). This is the exact logical opposite of trade entry.

Futures Calendar Spreads – Demo Account

Before you place any real trades here it is highly recommended use the IB demo trading mode of Paper Trading. Click “Try the demo” link below from the IB login screen. The IB future trading interface is somewhat non intuitive and requires a reasonable learning curve to fully understand what futures positions are being represented.

Interactive Brokers Paper Trading Login - Futures Calendar Spreads

Trade Entry

Trade Entry was on 27th Feb 2018

NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180227 Trade Entry

These are screenshots of entering the order from the demo system. Using the demo system for dummy order execution avoids accidental executions with “real” money. Please note that the market has moved so that the demo system screenshots do not match the above “real” trade entry executions – however the process to follow remains identical.

For some historical context, this is the 1 year chart of the spread:
NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180227 Trade Entry - Chart 1 Year

This is where to select the relevant menu item from the SpreadTrader utility:
NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180227 Trade Entry - SpreadTrader Start menu

This is how to select the front month and back month. Importantly can not select just one calendar spread, must select two or more spreads otherwise the “Finish” button does not appear.

NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180227 Trade Entry - SpreadTrader Configure Futures Spreads

Click on the relevant “ask” for the calendar spread and the following order entry will appear.
As we are selling, make sure the limit price starts higher than current Ask.

NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180227 Trade Entry - SpreadTrader Order Entry

Followed by this order display:
NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180227 Trade Entry - SpreadTrader Order Display

Walk down the limit price downwards (because we are selling) by 0.001 increments on the order until you achieve a fill.

Trade Update

This trade update was on 18th April 2018 to enter a GTC order to allow possible trade exit after the time frame for the 30 day rule has elapsed.

Identify the long future leg in the front month from the Account Positions, and select Contract Description menu:

NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180418 Trade Update - Long Leg

Review the contract description and note the symbol. In this case the symbol is NGM8. Verify that the futures contract named month and actual expiration date are as expected.
NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180418 Trade Update - Long Leg Contract Description

Repeat process for the short future leg in the back month from the Account Positions, and select Contract Description menu:
NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180418 Trade Update - Short Leg

Review the contract description and note the symbol. In this case the symbol is NGQ8.
NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180418 Trade Update - Short Leg Contract Description

Now look at the chart to identify a target exit price. Create a new chart of the calendar futures spread that is the long near month contract minus the short back month contract
Cut and paste NGM8-NGQ8 into the chart symbol entry text box and press ENTER. In this example NGM8 Jun 18 is the near month and NGQ8 Aug 18 is the back month.
Important – note that the label shown on the chart is the exact OPPOSITE way to what was entered!

NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180418 Trade Update - Chart 2 Months

Now create limit order exit trade to Buy. Right click on the chart and select Buy and drag down the line significantly underneath the chart. Click the “T” on the order.

To exit this trade need to sell the near month (that is long Jun 18 position) and buy back the far month (that is short Aug 18 position). IB defines this exit trade as a Buy 1 Calendar Spread. Since we are buying, start limit order with a low limit price, so that it can be cancel and corrected (updated) multiple times to achieve a better price. In this example started at 0.038. See the screenshots below for an example order.

Order Entry:
NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180418 Trade Update - SpreadTrader Order Entry

Order Preview:
NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180418 Trade Update - Short Leg Order Preview

Active Orders:
NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180418 Trade Update - Orders

Trade Summary

Looking at the chart, trying to achieve the lowest price makes sense, as we wish the difference between the near month Jun 18 and far month Aug 18 to shrink not expand. This can be a good til cancelled (GTC) order that can be hung out there until a price target is achieved – historically there seems to be support at 0.040 to 0.030 range, so that could be a good starting target (but you can obviously adjust for your trading style). If you want to get an immediate fill on a trade exit today, then just cancel and correct the order in 0.001 increments until it fills. Alternatively you can leave the order out there for the trading day to see if anyone nibbles at it, then get more aggressive on closing it nearer the end of the day.

NG Feb 2018 Short Futures Calendar NGM8 - NGQ8 20180418 Trade Update - Chart 6 Month Limit Order

In theory most futures calendar spreads are mean reverting, so we are looking for a move back towards the long term mean to capture some gain. We are not looking to make a killing on the directional trade – even though this is a “long” natural gas trade it usually a pretty slow moving spread. Additionally the spread may only go into that range for a few hours or days during its remaining trade lifecycle into end of May expiration, so we just want to grab a good price with a GTC if it’s there. Also we don’t want to hang around for the unpredictable spread volatility for the 2 weeks or so prior to expiration, so if it is still open at that time we’d probably just close when it gets too close to expiration.

Exiting Bitcoin Investment Trust due to Premium

This trade exit on GBTC describes how exiting Bitcoin Investment Trust due to premium was decided. The original GBTC position was purchased in March 2017. To recap the GBTC is an investment trust whose price is tied to bitcoin. The historically high premium to the actual underlying bitcoin price is the main reasoning for selling our GBTC position and replacing it with bitcoin and etheruem products that can replicate similar exposure (without that premium). This trade was IRA eligible so there was no issue of paying extra capital gains by selling after 11 months (instead of waiting for 12 months for long term capital gains to kick in).

Exiting Bitcoin Investment Trust due to Premium

The charts below compares an European based Bitcoin fund SE:BITCOIN.XBT (as a proxy for Bitcoin spot price) with GBTC. This clearly shows that throughout 2017 people have been prepared to pay a huge premium to own bitcoin in their US based brokerage account.

GBTC Feb 2018 1 year trailing premium
Bitcoin Investment Trust GBTC Trade Exit - Feb 2018 1 year trailing premium - 20180215

GBTC Feb 2018 3 month trailing premium
Bitcoin Investment Trust GBTC Trade Exit - Feb 2018 3 month trailing premium - 20180215

Combined with bullish Bitcoin 2017 price action and inflated premium, the GBTC price has moved up strongly. The above charts and Bloomberg show how the GBTC premium has moved for the last 12 months in a trading range of 50% to 120%. In only the last 3 months the GBTC premium has been as high as 120% in Dec 2017 and low as 30% in early Feb 2018. The premium trades aggressively higher on rallies and lower on sell offs. This behaviour has the effect of amplifying trading extremes, but increasingly makes it a less reliable buy and hold product.

As a recap, when the trade was entered in March 2017 GBTC premium had shrunk down to about 8% because there was the belief that a new Winklevoss Twins bitcoin ETF was about to be allowed by SEC. Once that was announcement was negative, the GBTC premium returned with a vengeance.

According to Bloomberg the average trailing 12 month GBTC premium was 53% (on 16th Feb 2017). By comparison the Bitcoin tracker fund premium was 0.08%. Additionally there is a 2.0% management fee associated with GBTC which is used to help manage the cold storage and security of the underlying bitcoin asset – so any premium paid on the actual GBTC spot price would seem to be excessive. The Bitcoin tracker fund management fee is 2.5% (higher) but since it trades at only 0.08% premium to NAV it is a relative “bargain”.

On 16th Feb 2017 GBTC had a 1 year performance return of 1,574.75% that more than double the Bitcoin tracker fund 1 year return of 774.33%. This is amazing given that the stated aim of the products is identical – the GBTC out performance results are exclusively due to premium.

For reference here are the Bitcoin and Ethereum products available that trade in Europe but can be traded in a US based brokerage account. These products do not have a huge premium to spot bitcoin and are IRA eligible. Bizarrely the swedish Krona product has the higher volume, over the Euro based product. All of these fund products introduce some currency risk exposure, but that is likely less to be way less variable than the GBTC premium risk.

Coin
Currency
Info
Bitcoin Swedish KronaCOINXBT:SS
Bitcoin EuroCOINXBE:SS
Ethereum Swedish KronaCOINXBE:SS
EthereumEuroCOINETHE:SS

A Good Trade but Poorly Traded

This GBTC trade was ultimately a great investment, but one that was traded frustratingly poorly.

A small tranche was sold in May 2017 to cover the risk on the original position and the rest was left to run as “house money”. Clearly with hindsight that was the “wrong” thing to do, but is it good risk management on a very volatile product – and allows staying in the trade for a much longer amount of time. This risk management part was not poor trading, but the management of the resulting price action in 2017 can be improved – as discussed below.

The final run up into Dec 2017 was not well traded, and therefore missed the significant peak at $39, and survived the drop to $10 in Feb 2017, so decided to exit with some value still intact at $18. This is a very hard trade to take psychologically because of the anchoring to the high point at $39. However the 1300% returns in less than a year is still amazing, yet disappointing from a trading perspective. The split adjusted entry point was $1.44 so clearly this was all “house money” but some exit trading at higher prices should have been achieved into the Dec 2017 peak. This is not purely hindsight – it was clear the short term nature of the blow off top, even during Dec 2017. This does not mean the end of the bitcoin “bubble” – just a medium term trading top that should have been taken advantage of.

Bitcoin Investment Trust premium – Trade Exit

GBTC premium expands on rallies (up to 120% in Dec 2017) and contracts on huge sell offs (down to 30% in early Feb 2017). On trade exit at about $18 that is approximately an average 80% premium, which is somewhere in the middle of the range extremes for the last year. On trade exit with bitcoin at approximately $10k, the book value (or NAV) of GBTC was about $10, therefore there is approximately $8 of premium to nav (or about 80%). Therefore about 1800 shares of GBTC buys approximately one bitcoin, but the book value is about 1000 shares. Clearly there is a convenience premium, but 80% over book value is very high. That does not mean GBTC price cannot rise further, or the premium increase more in 2018. However if the premium ever shrinks to say 30% then it is quite possible to lose money in GBTC even if the bitcoin price goes up. When you buy GBTC at $18 about 45% of your purchase is premium (or “fluff”) over the price of the underlying bitcoin. That is a very hefty premium to spot.

Trade Entry was at GBTC split adjusted $1.44 (actual pre split price at that time was $131) in March 2017 when bitcoin was approximately $1250. Trade exit was $17.96 when bitcoin was about $10025 in Feb 2018.

Trade Replacement

The GBTC investment can be replicated without premium using the Bitcoin tracker funds. Since 1000 shares of GBTC represents approximately 1 Bitcoin, these trading approaches could be taken:

1. Sell 1000 shares of GBTC ($18,000 USD) and purchase $10k Bitcoin tracker fund – this maintains exactly 1 Bitcoin exposure. The remaining $8000 premium can be maintained as cash for future purchases if there is a pull back or for other investments. This maintains bitcoin only exposure.

2. Sell 1000 GBTC then purchase $10k Bitcoin tracker fund and $8k Etheruem tracker fund. This gives exactly 1 Bitcoin exposure but allows using the GBTC premium to buy a new Etheruem position. This has created a slightly more diversified crypto portfolio – but still fully invested in crypto, with no cash on hand.

3. Sell 1000 GBTC then purchase $6k Bitcoin tracker, $6 Etheruem, and keep $6k cash. This gives a less aggressive portfolio because it keeps some cash on hand in case of a pull back.

4. Sell GBTC and maintain cash to wait for a big pullback to invest. If you are a believer in the long term crypto currency bull, this is arguably the biggest opportunity risk – crypto prices are hard to predict and can be notoriously bubbly – so it having exited once at lower prices it is hard to reestablish at significantly higher prices.

These reallocation strategies are all tax optimal in an IRA.

Summary

There is a significant chance that if there is a bullish BTC price march in 2018 towards $20k again then GBTC will do very well. Indeed one day later BTC is already trading 10% higher at $11,000 (so clearly this is proving a badly timed exit). However there need to be discipline to recognize when that the GBTC trade now has premium risk outside of just Bitcoin spot price risk. That risk can be resolved by selling GBTC and buying bitcoin tracker funds.

This is not necessarily a price extreme for bitcoin, but a potentially a premium extreme in GBTC. Still bullish on bitcoin and crypto assets for the next few years, however GBTC may not prove to be a good long term buy and hold product (due to the premium).

In summary this is not purely a bitcoin play, but has become a play on the premium investors are prepared to assign for the convenience of exchange traded bitcoin product. Importantly selling GBTC is a not a bearish call on bitcoin or crypto in general, just trying to avoid being the last one out when playing musical chairs with the premium trade.

Bitcoin Investment Trust Premium

This is a bitcoin investment trust premium idea from seekingalpha.com we have taken a position in last Friday.

Investment Setup

GBTC is an investment trust whose price is tied to bitcoin, with an extreme caveat that historically it has traded as sometimes astronomical premiums to the actual bitcoin price. The chart below clearly shows people have been prepared to pay a huge premium to own bitcoin in their brokerage account.

Bitcoin Investment Trust GBTC Price Arbitrage Idea - 20170310

The chart is not easily available online. It had to be created manually by downloading the time series for GBTC prices and bitcoin prices, then working out the “premium other NAV” between them. When this was done both the GBTC & bitcoin prices were indexed back to 100, and the “premium over NAV” was plotted on the same Excel chart. Note that each individual GBTC share represents 0.09336483 of a Bitcoin (BTC) – so that ratio need to be accounted for when calculating the premium.

These are some highlights from the chart:
- GBTC premium to bitcoin price has been as high as 100% down to 5% in last 12 months
- GBTC was trading at a significant premium (70% to 100% range) to actual bitcoin price in June/July 2016
- GBTC is now only trading as about a 5% to 10% to bitcoin price in March 2017
- This premium has trended lower in last 2 months in anticipation of new Winklevoss bitcoin ETF (COIN) getting SEC approval.

Short Term Investment Thesis

- If bitcoin ETF (COIN) is approved, then this premium should be reduced further – but GBTC price will rise due to bitcoin price
- If bitcoin ETF (COIN) is not approved, then premium should revert to 30% range & GBTC price should increase to reflect that
- Absent a huge bitcoin crash this should be a winning scenario in either case

Medium Term Investment Thesis

- Bitcoin is stable above $1000 for 2017
- Historical 30% premium to bitcoin price is restored, because there is no longer a viable pending Bitcoin ETF that would compete with GBTC.
- GBTC has applied to be listed on the NYSEARCA which is pending a decision by Oct 2017. It currently trades on OCTBB and if it moves off the bulletin board this should improve product liquidity and investor access. GBTC premium might trend up in anticipation of this a few months out from the announcement (something to watch).

Bitcoin Investment Trust premium – Trade Entry

Trade Entry was at GBTC $131 on Friday when bitcoin was approximately $1250. Trade exit would be when a the premium is restored to typical range greater than 30% – but we have to wait 30 days to exit due to 30 day rule.

Is lending crypto currency safe?

Excitingly it is now possible to lend out your Monero and other crypto currencies to other investors. Crypto currency lending is a bit like peer to peer lending for crypto, but the lending purpose is exclusively for other customers margin requirements (so not diversified). Lending crypto currency needs to be done via a crypto currency exchange where your currency is loaned to other exchange customers so that they can establish short or margin long crypto currency trading positions. This article chiefly considers lending out Monero (XMR), but the principal applies to any other crypto currency that allows exchange lending.

lending crypto currency

As an investor annual rates of return on any individual loan have ranged from 3% to over 100%. The rates on exchanges are typically quoted in daily returns, so a daily rate of 0.009% is approximately 3% – you can easily use any online calculators to convert any daily rate to an annual rate. An example annual to daily interest rate calculator is here (no affiliation).

We use Poloneix for lending, and find it gives good liquidity and relatively simple trading interface and order book. There are other platforms like Bitfinex but haven’t used them for lending.

As of October 2016 to our knowledge, no one has ever lost significant money lending Monero (or any crypto currency) on poloniex or other exchanges (so far). However before you go “all in” there are some significant risks to be aware of. The attractive returns are not just a free lunch. Here are some basic risks…

Margin risk

The main issue with exchange lending is it assumes that the exchanges algorithm for exiting customers out of their margined positions will not result in major loss. Essentially when lending on the exchange, your xmr is loaned to other exchange customers so that they can establish short or margin long positions. As usual for margin trading the exchange requires some capital level to be maintained in a customers exchange account, for the duration of their short or margin trade. If the crypto currency market moves against the customers positions and they no longer have the margin capital required to maintain their position, then the position will be exited by the exchange. This will likely be at a sizable customer loss. The theory is that the exchange has modeled the maximum likely amount capital required across ALL customers to meet an extreme move.

In theory the crazy moves should occur rarely and the exchange should be able to control any loses by forcing customers to liquidate their positions in real time. Basically they can take out multiple customers over their margin limit, but in theory not all customers at the same time should be affected (in theory!). However in practice these huge moves tend to happen more frequently than the statistics would predict. A good recent real life example is when the Swiss franc move meant several foreign exchange (FX) trading firms had to eat a few million of customer losses. This was in the FX currency market, but the principal could easily apply to crypto currency lending. Therefore you are depending on your exchange to have well executed customer margin requirements and forced trading position liquidation strategy.

Platform risk

Exchange lending and indeed storing any crypto currency on any exchange is subject to platform risk. That is the risk that the actual exchange platform fails and you lose some or all of your crypto currency balance. This could occur through hacking of poor exchange security or even an issue with the particular crypto protocol that can be exploited. Basically there is a slight possibility that your coin on an exchange just disappears overnight. You can obviously reduce hacking risk on your individual account by using website security features like two factor authentication. However that doesn’t guard against back door hacking exploits at the exchange level. You should probably keep no more than 20% of your entire stash with one website, and even possibly budget for 20% of it disappearing every 3 years! For example, storage solutions for monero are to maintain a cold storage (off exchange wallet) under your control. That requires significant technical know how to setup, but is likely worth it to maintain your stash securely.

If you don’t think that exchange default can happen look at the historical hacks on mtgox Bitcoin (March 2014) and bitfinex (August 2016).

Important takeaways highlight these two possibilities storing your coin on exchanges:
- total loss: many mtgox investors lost all their bitcoins
- partial loss: Bitfinex distributed the losses against all customer balances irrespective of cash or coin.

The Bitfinex partial loss example has an interesting piece of moral hazard. Note that even though only Bitcoins got hacked, ALL the OTHER coin balances on your reduced by 36% and were replaced with an exchange IOU! Essentially you were exposed to Bitcoin security flaws even if you had zero Bitcoin balance – which seems somewhat logically unfair. The point is that you could be exposed to balance loss for any coin on an exchange – even you did not think you were.

Is lending crypto currency safe?

The non bitcoin crypto lending market is typically less than 2 years old for most coins. Lending crypto currency on any exchange may mean that there may technology glitches (eg unable to liquidate as required) or lack of volume (eg not able to lend out all the currency you wish to, because there are not enough people to lend to). However we have tried this though and have been able to lend out several thousand XMR for about a week relatively easily. The % return is potentially good for the risk, typically earning about 5% to 15% annualised on average – even if you have some loans in the 15% to 100% range – typically it is hard to get an entire portfolio allocated at those interest rates.

This also all assumes a relatively low default rate which may not be true for people trading crypto currency on margin in the long term (only have a few months of real data to work from). It maybe long term profitable as well, but given that that there are no statistics yet on this market, it is hard to make accurate projections. However if using US equity lending as an example, most brokerages seem happy to lend to you at about 6%, so assuming the underwriting model for margin accounts is similar, then this could offer decent long term returns.

This approach is also somewhat similar to peer to peer lending (eg prosper and lendingclub), so could offer similar returns, but is probably a level up on the risk spectrum (above say junk bonds). Bear in mind that any defaults that occur could be long term expensive, because you lose out on the long term price appreciation potential of your currency of choice – it would be disappointing if you lost half your coin stash on lending, only to see your chosen coin price rise into the clouds in the following months.

In summary, it is worth a look as an idea, but there is significant “very bad event” risk for any crypto currency exchange platform that is hard to quantify. It would almost definitely not be prudent lending out your entire monero stash, in case in does not perform as expected. However investing about 5% to 25% of your monero stash in margin lending can give you “pseudo dividend” on an investment which otherwise doesn’t yield anything – but you might wish to spread your lending over multiple exchanges.

Protecting Foreign Real Estate against FX rate moves

Protecting Foreign Real Estate against FX rate moves is important if you own overseas property.
Protecting Foreign Real Estate against FX rate
We currently own one cash flow positive property with no mortgage in Canada, and are in process of buying a 2nd property. Basically we are looking to achieve a few things:

  1. Diversify away from US dollars (USD) using foreign currency in a stable country
  2. Get long some oil using the commodity currency Canadian dollar (CAD) as proxy. This works because crude oil and CAD are positively correlated.
  3. Get some relatively cheap real estate in a different country, to diversify away from a high cost US area where we live.

Our home currency is US dollars (USD) and the properties will be run in Canada with all local Canadian dollar (CAD) income and expenses. The plan is to take a commercial mortgage in Canadian dollars (CAD) across two houses at 50% Loan To Value (LTV). From a US dollar (USD) perspective this is essentially long / short CAD in almost equal amounts, where the house equity is “long” Canadian dollars and the mortgage is short Canadian dollars.

Obviously this still has all the usual real estate risk locally, such as local economy downturn, vacancy periods, high maintenance expenses (etc). This assume that both property will be cash flow positive (they will) and because we have a local property manager, they essentially run themselves. Again here we made sure both properties are initially cash flow positive so should be able to hold long term – we are have given enough margin of safety with 50% equity that we can safely (hopefully) assume that should not be forced to sell even if local property prices were to significantly decline. There are no planned foreign exchange (FX) conversions planned in the day to day running of the Canadian properties.

In summary the 2 properties would be exactly 50% long 50% short CAD (house equity/mortgage) with built in equity cash flow (the rent minus expenses).

Risks

Below we can see that there are a few risks to owning foreign properties. We will focus mostly on FX risk for this discussion, but it is worth highlighting the others below.

  1. FX risk. With our 2 properties if the CAD USD FX rate declines so much, we would have a paper loss in USD due to the original equity we have in the properties – even if all other factors like local house prices and monthly operations are constant.
  2. Local real estate risk. The local economy could have a significant downturn, we could have issues with vacancy periods, property may require higher than estimated maintenance expenses. These are the standard real estate risks, just that they need to managed remotely by our property manager.
  3. Pay Bid/ask spread on any FX transactions. Every time money is sent to Canada we have to pay the bid/ask spread on FX conversion. We use a currency dealer who gives decent spreads (approx 0.7%), which is not great, but significantly better than main street banks.
  4. Local company regulations to run a real estate company. There are initial company setup fees, annual province (state) filing fees to maintain a Canadian holding company to own the real estate. Need to maintain a Canadian based accountant who is familiar with Canadian tax law. There is an annual cost of holding real estate in a Canadian entity, however these pro-rota into annual property expenses and are covered by the rental income. The company does not require extra money to be added annually to cover these costs. However this require effort to ensure compliance with regulatory, legal and tax obligations for owning property in Canada – however the because it being held in full Canadian based entity paying Canadian taxes crucially . Most importantly no tax is withheld on rental income because the company is considered a Canadian resident – so there are benefits to doing the extra paperwork.
  5. Bankruptcy risk on company operations. The cash flow is not sufficient to maintain operations and/or a unforeseen event occurs that makes your real estate business operations not viable. However because this was setup inside a company structure, then this limited only to the real estate itself, not your personal finances.
  6. Sovereign country risk in Canada. Economic issues such as lower oil prices or a recession could make real estate prices decline or make it find to locate well qualified local renters. This is the same in any real estate investment, however the Canada economy is typically more tuned to commodity cycles than the US economy. Current central bank strategy between are different US and Canada – where US Federal Reserve is raising rates, while Bank of Canada is holding rates. Canada was also in a technical recession for last 2 quarters (but has lifted in latest quarter) – USA has been steady so is currently relatively more attractive. However the Nova Scotia economy is separated from the larger cities of Vancouver/Toronto/Calgary – it will be impacted by economic cycles but traditionally they don’t tend to have huge commodity boom/bust cycles. CAD is commodity funding currency, so about 80% correlated to moves in Oil. Oil prices have moved down from $110 to $40 ish. Importantly it is worth noting that currencies are also relative not absolute – even with a recession, if Canada does “better” than USA then its currency could rise versus USD. CAD USD FX Rate is not as correlated with standard equity markets, more commodities, but it has a full service based economy (essentially tied to the US economy) and its not Brazil (e.g. not just taking a punt on an emerging market currency just as a commodity play).

US v. Canada mortgages

There are some differences between Canada and US mortgage markets for primary residences and rental properties. Mortgage interest is not deductible on primary residence for an individual in Canada (as distinct from US where it is), however mortgage interest is deductible on rental properties. Although there is no capital gains tax (or gains limit) on primary residence.

Given that, some Canadians do rent their primary residence and buy rental property, rather than necessarily buy own home. Essentially this can be a viable option because of the tax code. Long term renting where you live (and buying rental property investment with the spare cash) could make more sense. Whereas in the US, the tax code is massively skewed to buying your primary residence.

Plus most Canadians banks keep mortgage loans on their books – that is they don’t securitise or resell loans straight away to other banks like they have in US. Therefore a Canadian bank is highly motivated to make sure their own underwriting is effective, because they could be carrying the loan for up to 25 years (which explains why big bank lending can be relatively cautious).

This explains the relative historical stability of the Canadian housing market. The differences between the US and Canadian mortgage market explain some of the slightly more cautious lending practices, but frankly that makes it more attractive as an investment. Canadian mortgage market is actually slightly different to the US market, but in a good way for investments.

We found commercial mortgage underwriting standards very strict, maximum they would do was 65% LTV (and they were still debating that..). Other banks would do higher LTV, but they require a significant financial deposit or savings to be with the bank before the loan would be advanced (sometimes up to 50% of actual loan size was required to be on deposit!). Local credit unions had more flexible terms underwriting terms than the big banks.

FX Rate Risk – Historical Moves

Now let us have a look at the historical moves of USD CAD FX rate to see what risk we are actually taking on. We will look at historically what was the largest FX move where Cad strengths (moves against you) on an annual basis in percent terms. For example the total percent depreciation was -24% in last 5 years (% move where start date is T-5 years and end date is today). However that is not typical and is a significant down move, however that is why the the investment opportunity exists.

Below is historically what what were annual USD CAD FX moves in percent terms since early 1990s. These have been calculated from a spreadsheet that uses average monthly prices (for each month) from Jan to Jan – it is not 1st Jan to 31st Dec – but they give an indication of expected historical annual moves.

In the following table a positive percent means USD weakens against CAD (investment makes money). A negative move means USD strengthens against CAD (investment loses money).

Year
Percent move
19901.44
1991-0.02
1992-12.05
1993-3.96
1994-9.68
19954.64
19961.58
1997-8.85
1998-8.23
19997.28
2000-5.38
2001-9.77
20025.94
200324.47
20047.19
20056.54
2006-1.71
200716.61
2008-21.68
200918.39
20104.89
2011-1.93
20122.06
2013-10.11
2014-10.5
2015-9.6
2016 (YTD)8.5

Based on this you can see that there were typically price movements in the annual range of -10% to 10% volatility, however the last 3 years have been double digit declines every year (which is unusual).

FX Rate Scenarios

This section will look at USD CAD FX rate scenarios where it stays the same, goes up or goes down (think we covered every possible angle in the investment world there!).

  1. Stays the same or goes up. If the CAD stays the same or appreciates we would probably just hold. If it appreciates very significantly it might be worth send back any cash flow in appreciated CAD into depreciating USD. This return of cash flow would act as a psuedo annual dividend. Ultimately in several years if there is significant FX rate appreciation it could be worth just selling one or both properties and converting it back to USD. It is completely possible you might make limited local real estate gains but significant FX gains due to FX rate appreciation. Importantly FX gains are not taxable, but obviously you have pay local Canadian taxes on any capital gains. The mortgage will be a greater debt in USD so you would not want to use USD to pay down the mortgage, just use local CAD cash flow for that.
  2. Goes down. If the CAD depreciated further the total real estate investment starts to lose money mark to market in USD. This is probably not a problem in local CAD currency to manage monthly operations, however it is still a mark to market loss that we might wish to reduce. Additionally with a significant move of say 10% or more we would consider paying down some mortgage principal (in CAD) with strategic annual USD to CAD transfers (as the rate is in our favour). Since a major risk to our investment is if the FX rate declines, in the next section we will look at some possible strategies to help manage that scenario. These strategies will be to pay down the mortgage or hedge the FX rate.

FX Rates risk management – hedge FX rate

The main question we have to ask is, do we technically even need to hedge with a 50% / 50% split of mortgage / equity all based in CAD currency?

The mortgage is in CAD and we are amortized principal payments in CAD. So on one hand we are long 50% in CAD exposure due to the real estate value (at 50% LTV). But on the other hand if you are taking a loan in CAD, you are short 50% CAD because you benefit from the USD strengthening. The exact 50% / 50% split of an asset in CAD vs liability in CAD, gives a built in natural hedge.

Also if we are going to hedge how aggressively should it be done ? There is a fair amount of equity (long CAD) position in the real estate, however as an investor it is better to take a view and hedge less. There is no value in hedging away all the risk to invalidate the actual investment idea.

It is possible to use /6C Canadian dollar futures put options to “disaster hedge” the FX rate. We are already holding a 5% OTM put 6 months or 1 year out for contracts of /6C, hedging at about a 0.25 delta on average. These are then rolled up or down after a few months as necessary as the FX rate moves. Additionally it is then possible to sell OTM call spreads against FX rate for income, to slightly offset the cost every month. If FX rate declined 10% would probably recycle that money into CAD mortgage and re-hedge. As long as keep long term OTM hedges in place this can be relatively cheap less than 1.5% a year of total investment – and that assumes zero gains from short call spreads which is not likely if rate declined. This is managed in a trading account along with other spreads (eg Long gold, short oil etc). Ideally it would just lose a small amount of money each year (which other spread can make up for) which is what happened so far this year. Fundamentally we would see this real estate investment as a married put strategy (long 2 houses in CAD, with long contracts on /6C futures put) on a dividend paying stock (small monthly rental cash flow profit plus paying down mortgage).

If rate went down 20% in a year you would lose money mark to market, but it would probably lose only say max 5% to 10% in a year (depending on option rolls). This assumes no other variables change, and assuming no gains from overlay trades and ignoring mortgage paid down which is about 1.25% of principal risked in first year. But point is that now the investment is not undefined FX risk. Any profit on hedges could either kept as cash or Fx back over to pay mortgage.

The issues are that it costs some money to hedge, but we are used to managing it as a trading account anyway. Leverage on those options is very good in a rate crash scenario. There are also cheaper / limited risk reward ways to keep short delta eg put calendar and ATM call spreads. As long as the “disaster hedge” with the 3 contract /6C put is always in place (in case the floor falls out again) should be ok. For example, when FX rate crashed in Jan 2016 that put option made significant USD dollar amount. Hedges are based in a USD trading account.

Ultimately in several years time you have 2 houses and lower mortgage principal, so over time your FX risk (CAD principal) increases so might have to increase hedging size later on.

FX risk management – pay down mortgage

If rate goes down 10% against CAD, the mortgage can be paid back with more valuable USD dollars. Any significant mortgage principal reductions early in the lifetime of a mortgage can have reduce the ultimate pay back time.
Therefore it would seem sensible to do a small principal payment (say between 1% to 10%) each year to reduce the mortgage if the FX rate is consistently in your favour.

However don’t want to pay down too much of mortgage, because you are increasing your long exposure to CAD each time you do that. Effectively you might be removing your hedge against a depreciating currency when you might need it most.

Conclusion

Even if the CAD currency is beaten up due to a lower oil price, Nova Scotia is a relatively diversified local economy on multiple sectors (not heavily oil related like some western Canada economies). Historically steady not commodity boom and bust (even in 2009). Also real estate is reasonably priced even in local currency, and it’s a buyers market there. Don’t need to make a killing in local landlord market, just need to keep lights on. Worse case mortgage is paid back in 25 years (typically commercial mortgage length in Canada) not 30 years like US residential mortgage. Plus ultimately own 2 houses at the end of the investment, which should more than match any FX move.

We decide to hedge, but keep it light. Hedging is an art no right or wrong answer. Since basically we were looking to diversify a bit from USD, want to get long some oil (via CAD) and own local real estate it is a good transaction. We only hedged approximately half our exposure, so if there is a strong oil rally you win on the original investment idea, and don’t lose too much hedging. Also if the FX rate moves significantly against us then the hedging will help and we could pay down the mortgage more. There is “no free lunch” (is there ever?) but the risks can be managed, and a significant move in the FX rate in either direction can still hopefully be managed to our advantage.