For those unfamiliar with the term, a Put Option is a leveraged derivative on a stock or index designed to make a large profit with a small investment in an expected market decline. They are also purchased as portfolio protection for an investor who is fully invested but also expects a correction, since the leveraged profit from the put will offset at least some of the losses the rest of the portfolio will experience in a market decline.
Since the economy and markets are considered to be protected by Fed Chairman Bernanke’s assurances that the Fed will come to the rescue if needed to limit losses, that assurance has become known as the ‘Bernanke Put’.
So let’s compare the ‘Bernanke put’ to another feature of Put Options.
Put Options are available with different ‘strike prices’. ‘Out-of the money’ strike prices are usually chosen for portfolio protection simply because they are much less expensive than ‘in-the-money’ options.
So if the SPY index is currently selling at $141, you might buy a put option with a strike price 10% lower, say $125. Other factors come into play like the time premium in the price, which gives the option some value even when its ‘out of the money’. But for the purposes of the point I’m making, if in a correction the price of the underlying index declines less than 10% there will not be any protection as the value of the put declines until it expires worthless. But if the market declines more than 10%, the protection will potentially become significant. A Put with a strike price 20% below the index’s current level would be in the money if the index declines 20%.
My point is that yes, there is a Bernanke put, but what is its strike price?
Unlike normal Put options we don’t get to choose the strike price of the Bernanke put. The Fed doesn’t reveal at what point in a market decline it would decide to strike.
In 2010, even as the economy slowed dramatically after the stimulus efforts of 2008 and 2009 began to expire, and the market was in a worsening summer correction, the Fed did not come to the rescue with QE2 until the S&P 500 was down 16%.
Last year, under similar conditions of the economy slowing again after the influence of QE2 ran out, and the market was again in a summer correction, the Fed waited until the S&P 500 was down 18.5% to come to the rescue with ‘operation twist’.
We won’t talk about 2008 when the Fed jumped in repeatedly with wheelbarrows full of ‘puts’, or was it helicopter loads, and the market just kept plunging.
My point is that since June, by subtle changes in the wording of the Fed’s FOMC statements and Chairman Bernanke’s speeches, the market has been constantly led to believe that this year’s Bernanke Put is only a week or two away from coming to the rescue. That expectation has been kept alive even though the market has remained strong since June and continued to rise. That is not when a normal Put would be triggered. They only come into play in a market decline.
Is the Bernanke put any different?
The Fed has clearly been demonstrating that it is not different, that it will only come into play in a market decline, by repeatedly promising it will come to the rescue “if needed”, and taking no action.
Bernanke reiterated that approach in his much anticipated Jackson Hole speech yesterday, when he acknowledged dissatisfaction with the economic recovery but once again only said that “Taking due account of the uncertainties and limits of the Federal Reserve’s policy tools, the Federal Reserve will provide additional policy accommodation if needed.”
So the important question is not whether there is a Bernanke Put, but what is its strike price?
Did Bernanke End the Uncertainties?
It was expected that with his Jackson Hole speech yesterday, Fed Chairman Bernanke would finally end the uncertainties over the Fed’s intentions. No more ‘will they or won’t they’.
Did he succeed, or more to the point perhaps, did he even intend to (end the uncertainty) given that keeping it alive seems to work so well in keeping the market positive without having to act.
So let’s look at the headlines to see if the uncertainties were resolved, the debates ended.
Wall Street Journal: ‘”Fed Sets the Stage For Stimulus”.
Financial Times: “Bernanke Signals Fed Ready To Act.”
L.A. Times: “Bernanke Signals New Economic Stimulus.”
Newsday: “Fed Will Do More To Aid Economy.”
New York Times: ‘”Bernanke Speech Makes Detailed Case For Fed Action.”
Miami Herald: “Fed Chairman Signals More Stimulus Coming.”
Or did he?
Canada Globe and Mail: “Bernanke Signals New Stimulus ‘Likely’ in Wings.”
Bloomberg BusinessWeek: “Bernanke Refuses to Rule Out More Stimulus.”
Chicago Sun-Times: “Bernanke Leaves Door Open to More Easing.”
Reuters: “Bernanke Says Fed Ready to Act But Short on Specifics.”
Financial Times: “Bernanke Yields Little Over New QE.”
BBC (United Kingdom): “Bernanke Hints at Further Measures.”
Finance Yahoo: “Bernanke Said Fed Ready To Act But Didn’t Refer To Any Imminent Easing.”
CNBC Online: “Bernanke at Jackson Hole: No More Easing For Now.”
By the way Bernanke also revealed some of the reasons the Fed is in no rush to act.
In his speech he said the risks in providing this type of unconventional monetary policy (QE and operation twist) are that it:
“Could impair the functioning of securities markets. . . . could reduce public confidence in the Fed’s ability to exit smoothly from its accommodative policy at the appropriate time . . . could induce the imprudent reach for yield by some investors and threaten financial stability.”
Gold breakout looking real.
Our recent buy signal on gold is looking increasingly positive, but short-term resistance levels (not shown) still have to be breached.
To read my weekend newspaper column click here: Can The Stock Market Avoid Election Year Dip- August 31, 2012.
Subscribers to Street Smart Report: In addition to the charts and commentary in the ‘premium content’ area of this blog, the new issue of the newsletter and a hotline are in the subscribers’ area of the Street Smart Report website. from Wednesday. Meanwhile, please stay tuned to the premium content area of the blog and the hotline.