Trader’s Narrative

The continuous slow motion melting of the volatility index (CBOE’s VIX) has gotten a lot of attention lately. I briefly mentioned it last month when I pointed out that the VIX has shrunk to its lowest in 6 months. Now we are below 30 - which is not really an important milestone, except that it is a nice round number. And that we are now back where we were in September 2008 just around the time that Lehman Bros. blowed up good taking the rest of the market with it.

Here’s a long term chart of the VIX showing the significant support that it broke through to the downside:

While most people with some familiarity with the VIX automatically assume this means there’s a bull market around the corner, the truth is more nuanced. Here’s a zoomed in chart of the VIX showing that while we gapped lower and closed higher for the day, we still closed below 30.

My hunch is that there are two things happening right now. One is the always present movement of the VIX which is normal and derives from the options market. The other is the return to normalcy from an insane period of time. Believe it or not, there was a time that 30 was considered extreme. And yet, here we are approaching it from the other side!

According to Interactive Brokers: This brief analysis highlights the springboard rally for stocks as overly pessimistic conditions fade. As they do, watch for investors to overdo the volatility decline. As we keep noting, we’re still not out of the woods yet. Also, according to IB, there are 2.1 million VIX contracts expiring tomorrow with more than a third being calls (people betting that the VIX would go higher).

As Eddy helpfully pointed out:

Since 1990, when the VIX is below 15 (about 31% of the time), the S&P’s annualized return is 7.8%.
When the VIX is between 15 and 20 (27% of the time), the S&P’s annualized return is 2.8%.
When the VIX is between 20 and 25 (22% of the time), the S&P’s annualized return is -1.5%.
When the VIX is over 25 (20% of the time), the S&P’s annualized return is 11.1%.
To the extent there’s a tipping point, it seems to be a VIX of 13. Above 13, the S&P shows an annualized return of 3.0%, below 13 it jumps to 14.1%. However, 13 is a very low VIX reading; it’s been below 13 about 18% of the time.

Below is an CNBC interview with Carter Worth, chief market technician at Oppenheimer Asset Management. Worth provides some perspective by mentioning that the average level for the VIX since its founding is around 19. Watch the video to see why Worth thinks the VIX’s trend is about to change:

Also, check out Barron’s: Don’t Get Euphoric About a Falling VIX

If you would like to receive a free copy of Robert Dorfman’s book, Hedge Fund Trading Secrets, enter the draw by leaving a brief comment at the above link (making sure you leave your correct email).

The Canadian government introduced a really smart new way for its citizens to save for their future by introducing Tax Free Savings Accounts (TFSA).

These are special accounts that allow your assets to grow sheltered from taxes. You can contribute up to $5000 a year (the limit for 2009) with this limit rising with inflation in $500 increments. As well, any unused contribution limits can be carried forward. So let’s say that you don’t contribute for 5 years and then receive an inheritance of $25,000. You would be able to put that lump sum and have it grow tax free. But any contribution over the $5000 a year limit gets a 1% a month penalty (similar to Registered Retirement Savings Plans).

Unlike RRSPs, you don’t need to have any income to make contributions to a TFSA account. But neither will you receive any tax benefit for simply making such a contribution.

The really amazing thing is that you can also withdraw the money at any time with no tax consequences! So unlike a RESP or RRSP your money is not locked in. And since contribution limits are carried forward, when you make a withdrawal, you have increased the contribution amount for future years by the same amount.

But the real flexibility of this new account is that it can hold bonds, GICs, mutual funds, equities and equity options. So if you combine it with a brokerage account that would allow you to trade the account, you have the best of both worlds: a trading account which grows tax free!

Although I still like and recommend Interactive Brokers to active traders and even lackadaisical long term investors, for some reason, they refuse to offer registered plans (RRSPs, RESPs, or TFSAs).

Knowing Interactive Brokers’ penchant for thrift, it probably has to do with the cost and human labor involved with setting up and administering such accounts. So with Interactive Brokers out of the picture, Canadians who want to open up a TFSA are left with the usual options of the big banks as well as a few independent brokers.

I’ve looked at all the options out there, and for Canadians, the best option for a TFSA is Questrade.

If you are an IB client like me, something else that you may not have realized is that buried within the agreement you signed with Interactive Brokers, is a clause that says you must have another brokerage or trading account. So if you don’t already have a ‘back up’ account, this is a great way to set one up. Not only will you be earning tax free capital gains, dividends, interest, etc. but you will also be saving money by paying the lowest commission rate in Canada (second to IB).

Questrade Commissions
For equities, Questrade charges 1 cent a share, with a minimum of $4.95 and a maximum of $9.95 per trade. As well, with a regular Questrade account you can trade options, futures, forex, mutual funds and physical gold.

And on top of all that, as a reader of Trader’s Narrative, if you sign up using the link in the banner, you get $50 in free commissions! What else can you ask for?

With Questrade’s low commission structure and no annual fee, you can quickly transform your tax-free savings account into a tax-free trading account. Just imagine, within a few years of contributions, you can have $25,000+ growing tax free.

Disadvantages
Of course, the only disadvantage is that if you have losses in this account, you can’t use them to offset your taxes. So depending on how confident you are in your ability to be profitable in this account, you might want to use this as more of an investment account for high dividend paying stocks, REITs or bonds. But remember, since this is a registered account, you can trade and hold any asset in your Questrade TFSA account except forex and futures. And for the same reason, you can’t use margin - this is a cash account.

Since capital gains are already 50% tax-free, you might want to only include bonds or bond ETFs which would otherwise be taxed at the full amount. Another option is to take advantage of the bear market and buy a leveraged equity ETF to ride the recovery. Whatever your strategy, take the time to learn about this new option or speak with an advisor to find out how it can benefit you.

Today, most financial companies are an endangered species. But other brokers and investment banks may be struggling and getting government bailout money to spend on bonuses, Interactive Brokers (IBKR) goes from strength to strength.

They recently reported earnings for 2008 and for the first time they broke the billion dollar mark for income (before taxes and minority interests). When you consider this was done on revenues of only $1.85 billion, you get an idea of how tight a ship they run.

I’ve mentioned before that they are one of my favorite brokers and arguably the best broker out there for the non-proprietary trader. As a customer, it’s good to know that your broker is on solid financial footing - one less thing to worry about.

If you trade with them you soon get to love their SMART routing which gets you better prices at surprising frequency. Based on independent analysis by the Transaction Auditing Group, IB’s SMART routing beats the competition. You can get the full details here.

As well, they are continuing to roll out new products and expand their already impressive market reach:

• Korean Kospi 200 Futures and Index Options (for US resident customers) soon
• National Stock Exchange of India (NSE) equity - initially to residents of India but eventually to others
• …to be then followed by NSE index futures trading
• addition of American Century no-load mutual funds

You could argue that IB is becoming a quasi-prime broker. They are a one stop shop for equities, derivatives (options, as well as futures) in more than a dozen international stock markets. And they have forex to boot. Add to that mutual funds marketplace they implemented in recent years and you’ve got a top-notch brokerage firm.

But that doesn’t mean they are the perfect fit for you. I think they are definitely worth a look if you are an active trader or have a large portfolio. But you should do your own due diligence to find a broker that you’re happy with.

Here’s a chart of Interactive Broker’s (IBKR) stock price since their IPO:

As you can see from the chart, fundamentals count… but not really

I use Interactive Brokers as my primary broker because of their price and offering but also because they consistently improve and add new features. They put the Japanese companies to shame when it comes to kaizen.

Usually they follow the requests made by their clients - I’ve been with them long enough to remember a time they grudgingly gave in to demands for trailing stop losses because Thomas Peterffy believed they weren’t good for the health of markets (I am not kidding!!). But they also innovate and surprise their fans with new features.

They recently announced a raft of new features, products and markets. If you are a serious trader and looking for a broker, check them out.

Here are the recent additions:

New Products & Markets

• US Treasury Bonds and Notes
• Vanguard No-load Mutual Funds
• Mexican stocks, futures, and options
• Spanish stocks

The first two are huge news because as far as I can remember, we’ve been pestering IB for it. The even better news is that fixed income will be expanded soon to include T-Bills and that other mutual fund families will be added as well. IB was at one time proud that they stuck to just derivatives and equity markets. Finally, they are branching out to other financial products.

The expansion to Mexico and Spain are also welcomed. Especially since I have familiarity and interest in the Spanish equity market. IB has offered Spanish derivatives for some time but now the lineup is complete.

IB Block Desk
The biggest news is this! Interactive Brokers is opening up their institution block desk to retail customers. Now if your orders are big enough (100+ contracts), you can call them up and get a tighter spread or more liquidity than electronic markets. The desk also offers you access to the Spoos (the S&P 500 open outcry market or pit), OEX, NDX (and their options).

Answering calls will be experienced, knowledgeable traders who can tackle anything you throw at them, including complex derivative trades. But this is a very surprising development since Interactive Brokers has adamantly refused to do anything but push deeper into electronic markets through sophisticated trade matching computer algorithms.

IB Risk Navigator
This is a relatively new built in quantitative tool that will monitor and manage your risk exposure across countries, markets, currencies and securities. Think of it as your very own risk manager. IB has added a few extra capabilities to it but unless you trade a gamut of securities spanning markets or dabble in options heavily, then you probably don’t need it. In case you’re interested, IB is offering two Webinars to explain it in more detail: March 26th and April 23rd.

Trader Work Station
The TWS is the trading platform from IB and most people fall into two camps: they either love its simplicity or hate its clunky look (and Java-ness). In any case, IB isn’t going to chuck it any time soon so if you’re thinking of opening an account with IB this may be the only deal breaker. You can always use their web based interface but it has very limited functionality compared to the TWS. IB has finally tried to mollify its critics by adding skinning, so you can customize the look of the TWS.

I can’t help but think that a lot of these uncharacteristic new features and markets are a result of Interactive Brokers becoming a public entity last year.

If you’re shopping for a broker, click to see last year’s best broker ratings from Barron’s.

In case you’re looking for a retail broker or simply want to see how your current one stacks up against the competition, here’s the 2007 Barron’s Best Broker Ratings:

(Remember, retail brokers aren’t the only option. You can also trade with proprietary trading firms.)

Web-Based Brokers - Click to See Table:

Software-Based Brokers - Click to See Table:

Specialty Brokers - Click to See Table:

For further details, I’ve added the complete PDF of the Barron’s 2007 Online Broker Review in the FREE resource section - in the Reports & Articles folder. While you’re there, look around to find tonnes of other free trading related stuff (including whole books!) :