Monday, June 18, 2007

The Fed Model

The Recapitulator would like to take this opportunity to ask a simple little math problem:

What happens to a ratio when the denominator decreases
 and the numerator increases?

The P/E ratio (the inverse of its forward-earnings manifestation being the basis for comparison to the 10-year bond yield, which is also known as the "Fed Model"), which has never been a very good metric for valuation of companies in the REcapitulators opinion, owing to the usual retrospective/prospective predictive problems, has a special reverence for the public and sophisticated operators alike.

As for the Fed model, it has had a pretty good fun for predictive value.  The Recapitulator has long thought July expiry is a good month for short VIX puts (or hey, why not "Texas Hedge" and go long some calls or long some futures???) and he still thinks so.  As bond yields rise, forcing players to choose between similar yielding assets with vastly different risk profiles, and as the inverse of the forward earnings yield looks decidedly less rosy, we should see some excellent toing and froing next month.

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