Deal or No Deal?

We’ve heard major news about the “phase one” deal being finalised and markets have traded up on looming optimism. But let’s not forget that Hong Kong is in the midst of a violent pro-democracy protest.

Today, President Donald Trump signed legislation that expresses US support for protestors, a move that threatens ongoing negotiations.

The signed bill requires annual reviews of Hong Kong’s special trade status under American Law, as well as banning the export of crowd-control items such as tear gas and rubber bullets to the city’s police.

China’s foreign ministry responded with a threat of retaliation without offering details. Makes sense, because all China has to do is walk away. In my view, whoever has the ability to walk away first has more power in a relationship. In this instance, it is China.

Sure, one might argue that retaliation and the failure of a deal will hurt the Chinese economy, but the country has already taken measures to insure itself against certain risks. First, it offered a dollar bond sale worth $4.45 billion and then doubled down on the bet by planning its largest-ever $6 billion dollar bond sale.

What’s more is that China also holds large reserves of the US dollar, and can aggressively devalue its currency to make its exports more attractive in the global markets. The last time this happened, Trump called it “currency manipulation”, and responded back aggressively.

“I signed these bills out of respect for President Xi, China, and the people of Hong Kong,” the president said in a statement Wednesday. “They are being enacted in the hope that leaders and representatives of China and Hong Kong will be able to amicably settle their differences leading to long term peace and prosperity for all.”

But, uncertainty creates opportunity, such as this:

Here is one way to trade on a failed trade deal: you can BUY the $SPY PUT with strike 306.00 AND SELL (underwrite) the $SPY 305.00 PUT, with the expiration date for BOTH being Dec ‘20. The cost of the spread is $0.11, and the trade is hedged, which is to say that your profits are capped along with your losses.

Your maximum profit is $890, and your maximum loss is $110, (for 10 contracts, excluding commissions). You’ll breakeven if $SPY closes at $305.89, and will get the maximum profit if it is anything below $305. You’ll get the maximum loss ($110) if the trade deal is finalised and $SPY closes above $306.

Your risk to reward is 1:8.09. Not bad huh!

The reason I would be bearish on the trade deal is because a failed deal would lead to panic selling and erode gains fairly easily in an overbought market. On the contrary, if the deal is finalised, I don’t think it will lead to panic buying because the market has already priced in the optimism.

You can try other combinations of the ‘put debit spread’ at different strike prices, but make sure to calculate your risk/reward and max profit/loss scenarios.

There are other ways to trade on the trade deal by buying derivatives on the $VIX as well, that will react to market volatility. As always, do your own due diligence, and this is NOT a recommendation to buy or sell any security.

---

Not QE continues

The repo market crisis continues as the Federal Reserve Bank of New York added $108.95 billion in temporary liquidity to the financial system on Wednesday.

In a two-part process, the Fed first added $87.95 billion in repos, and then $21 billion in 15-day repos. “Not QE” has continued since mid-September, and the Fed’s operations are aimed at ensuring there is enough liquidity in the markets.

There are two main ways how T-Bill purchases support the prices of securities: the increase in cash assets and deposit liabilities on bank balance sheets, and the reduction of funding risk for leveraged buyers of treasuries.

The 2008 crisis was also in part caused by looser regulations by the FED that allowed excess liquidity and funding to pour into the markets. QE then was used as “dry-powder” injecting a large amount of cash as a measure of last resort.

Question is, why would you not call it QE? Well, one response is that it would signal concern about the financial markets that would run contrary to the Fed’s economic outlook that is “cautiously optimistic”. Another response, one that I am more inclined to side with, is that the Fed has moved on from its role in the economy to use monetary policy to regulate interest rate and inflation, but has taken on the role of controlling liquidity in the financial markets.

Whether or not the Fed admits to doing so is a whole other thing, but it is certainly something it is actually doing.

---

MedMen’s Catastrophe

The firm reported another quarter of devastation, as the firm continues to struggle like many in the sector.

Q1 results saw $44 million in revenue, up from $42 million in the last quarter. Net loss for the quarter was $31 million.

You might say these results paint a good picture for the firm, except, you’d be wrong. The firm laid off about ~180 members of its staff to cut costs, something we covered earlier. With $42 million in cash on hand, $53 million in accounts payable, MedMen’s troubles amount to a grand total of $129 million in liabilities.

Sure, cutting costs saves money, but $11 million in interests payments along with $30 million in negative cash flow won’t stop the bleeding anytime soon.

“We entered Fiscal 2020 on a mission to build a more nimble and financially flexible MedMen,” Chief Executive Adam Bierman said in a statement. “As we right-size our organization and implement an intensified focus on free cash flow generation, our business will become more efficient, in turn allowing us to better serve our stakeholders.”

But here’s the thing about promises: they only work if you have credibility and if your investors think you will actually deliver instead of touring Narnia where positive EBITDA resides. The only saving grace the firm has, in my opinion, is maybe two or three quarters at best to prove they can turn things around.

The stock closed at $0.58 CAD, down over 87% from earlier this year in January.