An Invisible Hand to Slap the TSA

Anybody who has ever flown or willfully engaged themselves in an argument with a TSA officer over why dress from a more widely recognized religion need not be removed while that of an unknown (made up) belief system must be put through the metal detector can attest to the stupidity of those working the security checkpoints at our airports. Not only are the TSA largely of menial intelligence (what do you expect for $25,00 a year), but the policies are reactionary rather than proactive - think removing your shoes AFTER the shoe bomber has made an attempted strike. Next time I fly I would like to separate my 1 liter bottle of water between twelve 3 oz bottles just to show the idiocy of the policies.

What is the solution? Go private. Impose on the airlines a mandatory payment of $5 million for every passenger killed on a flight as the result of a terrorist attack, then let them handle the security of every passenger getting on their plane. The payment would take care of the incentive, and competition among airlines for service would ensure that security lines were run efficiently.

Of course airlines would likely outsource the security to specialized firms, but this would increase efficiency as well. Instead of the government watching over these firms, a capitalist business with an eye on the bottom line and competition would be. Further, we should force the airlines not only to assume the risk of $5M per person, but also be insured for that risk. That way the insurers would be tasked with making sure that the security procedures were adequate while the airline would be pushing for an easy experience in the security line to keep up with competition.

For all you socialists out there, this would likely INCREASE the pay of workers - those performing the security procedure - as there would be a demand for competent employees rather than government lackeys. For those who ring their hands and say that you can't put a price on human life, you may be right. However, policies put an implicit price on human life every day. If we slowed the speed limit to 5mph, we would have less traffic deaths, but the economic consequences of decreased mobility would be catastrophic. $5M is largely an arbitrary number to get the airlines' attention. It should be high enough that they (or their insurers) would never want to incur the cost, yet low enough that insurance premiums would not be too high. Who would likely do a better job with the security screening? An airline security team with an insurance company that is worried about losing hundreds of millions of dollars if it fails, or a government branch full of underpaid employees?

Why I Like UNG

Over the past two years, UNG would have been a terrible investment. Even as the stock market has retraced some of its losses, UNG stands at 15% of its peak.

 

However, even with the uptick of implied vol in the equity markets, the VIX is still at around 25. This doesn't compare with the hefty 45% implied vol in the UNG options. Here is the trade:

 

Sell February UNG 10 Puts at $0.33. With UNG at $10.32, it will have to fall 6% before you start losing money. If, on expiration, UNG has fallen, the implied vol will still let you either roll down those puts at a credit or let you sell calls against the stock. Here are some scenarios for the March options at February option expiration at 45% implied vol:

Even with a big selloff, you can still sell 10 calls against it and take in a premium of >1% a month. This also discounts the fact that negative moves are generally negatively correlated with implied volatility, so the premium would likely be more.

 

If it were to move down, I would roll down as much as I could while still being at a credit. For example, if UNG was at $9.50 and the puts were worth $0.50, I would buy back 2 of the Feb 10's and sell 1 of the March 10's and 1 of the March 9's at a credit of -2*$0.50 + $0.77 + $0.25 = $0.04.

The Situation

Sometimes I wish Wolf Blitzer would just get it over with and invite the Situation into the Situation Room. I wonder if he will bring his brother, Circumstance.

Cheap Vol.

After touching a dizzying height of 80, the VIX has steadily declined the last 15 months. All this despite 10% unemployment and a great deal of uncertainty as to how this scenario will play out. The VIX measures the annual implied volatility derived from options prices on the S&P 500. If you believe the VIX will rise, you can buy a VIX future. These, however, rarely trade at par. You could also buy a variance swap, but this gives you exposure to future realized volatility as well as implied volatility. With the stock market looking a bit heady, I think that the best trade is to go long at the money long dated SPY options and short short dated SPY options at the a slightly lower strike. That is:

Buy SPY Sep 113 Puts at $7.90
Sell SPY Feb 111 Puts at $1.32

Looking at the Greeks, for the put option you are long:
7.7 Theoretical Price
-0.46 Delta
0.02 Gamma
0.38 Vega
-0.01 Theta

For the put option you are short:
-0.35 Delta
0.07 Gamma
0.01 Gamma 1%
0.11 Vega
-0.04 Theta

You are net short the market (good thing), long gamma (good, but this can change), long vega (the original goal), and the theta shows that you are capturing time decay on these options.

As the short dated option expires, I would sell a March option a couple of points out of the money (but never higher than the strike of the long dated options). If the option is set to expire in the money, I would try to roll down at a credit. In all, these types of trades could prove to be profitable with an uptick in implied volatility or with a market drop. There is also a limited downside to this, as your total loss is capped at $7.90 - $1.32 = $6.58. This does not even take into account that $1 - $1.50 that you can take in every month until expiration.