Why the market is down now for 2 days.

The US stock market indices are down this week for one simple reason: POLITICS. Nothing else has changed.

NYT: G.O.P. Extracts Price for Averting Shutdown

WaPo: We’re two days away from a government shutdown. Here’s what’s at stake.

IBT: Government Shutdown 2014: What Will Happen If The Federal Government Doesn't Pass A Budget

The Case for Transocean

Thanks to a poorly constructed stock screen, I ended up entering a bullish option spread on Transocean, Ltd (RIG). This has been quite a bad trade, but since it is inside a test portfolio, I have not divested of it to experiment on how to salvage a bad situation.

The purpose of this post is to spell out the reasons I think RIG is a good company in the middle of a cyclical bloodbath. Without going into detail of my ideas on it, here are the main reasons I think this stock will recuperate quite well once oil prices stabilize.

1. The large dividend is safe because of the financial flexibility provided to it by the MLP RIGP.
2. Transocean opened a $3B 5 year revolving credit facility on June 2014. (See 10-Q for details)
3. Also according to the 10-Q, Scheduled Maturities over the next quarters ending in 3Q16 equal $1.4B. This figure does not include the $207M redemption in November of the outstanding 4.95% Senior Notes due 2015.
4. The balance sheet is healthy as attested by Fitch in November: "Fitch views the timing of this month's impairment as a signal to the oversupplied market that, consistent with our view, industry-wide rationalization is needed ahead of scheduled newbuild deliveries to improve market balance and, ultimately, realize a cyclical improvement. Transocean has illustrated that rationalization can strengthen its cash flow and asset profile. This is evidenced by the stabilization of EBITDA and improvements in utilization and day rates following its 2011 impairment."
5. Fitch rates Transocean as Stable BBB-, the lowest of Investment grades. But the implied rating based on the CDS price is a much better BB-.
6. The $24B backlog of contracts should allow RIG to keep the fleet at work through the downturn even if it lasts into 2016. Note that in the November Fleet Summary, the expected Out of Service days actually went down by 225 for 2015.

Based on the financials, RIG should be well positioned to go up once the oil market stabilizes from its swan dive and the oil producers are able to reengage in Capital Expenditure planning.

Electricity Utilities Should Do Well For A Little Longer.

Utilities tend to be the boring but stable part of most investors' portfolios. With their steady income streams and reliable dividends, they tend to act as a bond with a growing coupon would. They also tend to have low Betas, i.e. low reactivity to broader market swings.

Current market conditions favor electric utility stocks on several fronts:

1. Low energy input prices, such as gas, oil and coal are expected for the foreseeable future.
2. As bond equivalents, they should lose favor as interest go up. Few investors are expecting any large moves from the Fed and other Central Banks have only just begun to flood the markets with liquidity, thus keeping interest rates on the low side.
3. As US GDP is expected to keep growing throughout 2015, electricity usage should be stable.

If oil and coal prices go up, or interest rates begin going up, this could likely bring utility stocks down as prices go up and bond yields become more attractive.

Two stocks I find attractive are Consolidated Edison (ED) and PG&E Corporation (PCG). They are both well ranked within the industry, have favorable earnings momentum and comfortably below their Price Targets.

I am currently using a Positive Delta, Positive Theta option spread strategy on both these low Beta plays. I can profit as long as price stays near or above the strike prices I use on each.

Market Indicators I Like: 1) VIX Futures Premium

From time to time, I'll be listing market technical indicators I use to gauge the strength of the US Stock Market.

From the front page of iVolatility.com, I like to look at the VIX Futures Premium. It measures how much more are hedgers willing to pay for Implied Volatility  (i.e. the risk premium for options on the S&P 500 Index) in the future two months than in the current spot market. If hedgers are worried of an upcoming downturn, they are likely to pay more for the current spot market protection than for future, bringing the Premium down to negative levels. If, on the other hand, hedgers are less worried about the risk of a market downturn, then they will be less eager to buy protection now, then in the future, making the Premium higher.

iVolatility instructs its users that a VIX Futures Premium:

Premiums for a normal term structure are 10% to 20%, while premiums above 15% appear to suggest a lack of enthusiasm for VIX hedging. Premiums less than 10% suggest caution and negative premiums are unsustainable suggesting an oversold condition. 

 Today at market open the premium is at +15.37% suggesting a continuation of the uptrend.

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