Options Trades Explained

To follow up on this story, this is what happens when you let conspiracy theorists practise finance without a license. From thestreet.com:

As if the mortgage-market meltdown wasn't enough to spook investors, some market players expressed concerns about unusual options bets that some observers
have dubbed "Bin Laden Trades."

The blogosphere and options trading desks have been rife with speculation about these trades, which are unusually large bets that the market will make a huge move in the next month. Some entity, or entities, has taken a large position on extremely deep in the money S&P 500 options, both puts and calls, that won't pay off unless the market undergoes an extremely large price move between now and the options' expiration on Sept. 21.

However, Dan Perper, a Partner at Peak 6, one of the largest option market makers and proprietary trading firms, has confirmed that the trades are part of a "box-spread trade."

"This was done as a package in which the box spread was used [as a] means of alternative financing at more attractive interest rates" explained Perper.

A Collision of Ironies

I am have been listening to all the chicken-little-sky-is-falling types predicting the imminent collapse of the dollar, while simultaneously praising the progressive socialist politics of Venezuelan dictator Hugo Chavez, so I chuckled while reading this article in the Wall Street Journal describing how his countrymen are buying up dollars like crazy due to the rapid inflation that Hugo has caused:

CARACAS, Venezuela—Like many people they know in Caracas these days, Alfred and Norma Muñoz are bracing for what they believe is inevitable: a currency crash brought about by President Hugo Chávez's policies.

The middle-class couple plan to borrow as much as they can from a local bank and buy an apartment outside the country. If Venezuela's bolívar plunges against the dollar, they figure, the loan will be cheap to pay off in dollar terms, and the overseas apartment will hold its dollar value. "Plus, it gives you somewhere to flee if things really get bad," says Mr. Muñoz, who runs a small business.

And I must say, this is one of the more creative arbitrage schemes I have heard. They didn't teach this in B-school.

Wealthier Venezuelans have discovered they can use credit cards to exploit the difference between official and black-market currency rates. Some have flown to the nearby island of Aruba and bought $5,000 worth of gambling chips, the maximum overseas credit purchase allowed by the Venezuelan government, according to a person who arranges the trips. They cash in the chips for dollars, then, back at home, buy enough bolívars on the black market to pay off the credit-card debt, this person says. They pocket the rest -- around $2,300 at current rates, more than enough to pay for the trip.

End of the World Imminent: Details at Five

The conspiracy theorists continue their panic over derivatives trading. Alex Jones' Prisonplanet.com has another article on the subject:

A mystery trader risks losing around $1 billion dollars after placing 245,000 put options on the Dow Jones Eurostoxx 50 index, leading many analysts to speculate that a stock market crash preceded by a new 9/11 style catastrophe could take place within the next month.

These people are so economically illiterate that he then quotes a blogger citing an entirely different alledged series of trades:

"The sales are being referred to by market traders as "bin Laden trades" because only an event on the scale of 9-11 could make these short-sell options valuable," reports financial blogger Marc Parent. Dow Jones Financial News first reported on the story.

Of course if you read the Dow Jones story, which actually does reference the right trades, you will find the explanation has nothing to do with conspiracy theories:

The identity of the investor is unknown but market sources speculated it was either a large hedge fund hedging itself against deepening losses, or a long-only fund manager pressing the panic button to protect its gains.

I cannot find it in any financial source, so I am not sure how these conspiracy theorists come up with "risks losing around $1 billion dollars". That would mean each option, cost over $4000. That is a lot of money for an option that is way out of the money. Any first year finance student will learn about Black-Scholes, which states that the value of an option decreases the farther away from the strike price you are. Nobody is going to risk $1 billion for a remote chance at making a maximum of EUR 6.9 billion, especially when even that is based on the unlikely event that all stocks will go to zero.

Incidently, this idea that they repeat that speculators made a killing off of puts on airline stocks before 9/11 is mostly urban legend. The amounts were actually quite modest, and the trades, although above average were nowhere near unprecendented. Alan Poteshman, from the University of Chicago has an interesting paper on the subject, although I don't agree completely with his methodology or conclusions.

Troofernomics: Part II

From one of the conspiracy idiots on the Loose Change Forum:

Disclaimer: I don't know this site and I can't confirm what they are saying. But the apparently there were some HUGE amounts of money spent on options by a single trader (individual, company?) totaling about $2 billion. The trade doesn't make sense except if the market crashed big time. Options only start making money if the stock market goes down 30%. Timeframe is between now and Sept.

http://www.tickerforum.org/cgi-ticker/akcs-www?post=4669

Here's how a guy summarized the situation:

"1) August 22nd, someone wrote almost$2 billion worth of calls that the market will tank in the next 3-4 weeks. Down by at least 30+%

2) The forum members think it's a hugemistake by someone and it won't"stick" over night.

3) Someone calls in some kind of optionshot line and guy confirms that it's legit,not a mistake. Guy sounds really worried.

4) Aug 23 they confirmed that this huge $2 BILLION CALL had indeed "stuck".

5) So, someone put a hell of a lot of moneyon the line that the market will crash inSeptember. They are either incredibly stupid,or know something we don't."

First of all, someone should point out that a call is an option that pays if the price goes UP, not down. A put option pays if the price goes down. Secondly options are not based on percentages, but on an exercise price that the seller sets. Lastly, even if someone buys a "put", it doesn't necessarily mean they think the market is going down, they could just be buying insurance on a long position that they don't want to unwind. I would be surprised if anyone is even selling this many puts that are so far out of the money anyway, unless one of the large brokerage houses just considers it an easy way to pad their profits.

Troofernomics

I follow the paranoid conspiracy theorists a lot, and it always amuses me when they branch into economics. In this case Alex Jones' Prisonplanet website interviews Jerome Corsi, the paranoid right-winger who is spreading all of the North American Union hype. While I certainly agree that the sub-prime mortgage fallout is serious, and there is even a possibility of a recession, his predictions of collapse are bizarre. One thing to keep in mind is that in the post-WWII era, recessions happen on average once every 6 years. The last recession was in 2001, it is now 2007, do the math. Recessions are not the sign of the collapse of western society, they are part of the business cycle unfortunately, until we can figure out how to avoid them entirely, the objective is simply to make them as minor as possible, which basically happened in 2001.



In any case, some of their absurdities:

Corsi urged anyone in the position to do so to quickly pay off any mortgages and get out of debt. Secondly he suggests investment in gold, rather than stocks and bonds which are based on fiat money and are going to decline tremendously in value:

Uhh genius, if you believe hyperinflation is coming, then why would you pay of your debt? Borrow more money, use it to buy assets (like gold), and then repay your debt with worthless dollars.

Corsi, who has a degree in political science, not economics, goes on to claim that this recession will last long because of our lack of exports.

"It's going to last several years, it's largely because we've lost so much of the manufacturing to China, even when our currency tanks, there are no exports we are producing anymore that will gain. The currency is gone, it is being sold off very quietly, worldwide, by the oil producing states, by China, the Euro is increasingly becoming our foreign exchange reserve currency.

This is an often repeated myth. We do not have a trade deficit however, because of a lack of exports, but because of an abundance of imports, as data readily available from the Bureau of Economic Analysis indicates:

History Repeats

I concentrated on finance during my recent MBA studies, and a case which was often repeated was that of Long-Term Capital Management, or LTCM. LTCM, despite being run by some of the brightest minds on Wall Street including a score of PhDs and even a couple of Nobel Prize winners, went bankrupt in 1998 during the Asian and Russian financial crises, and had to be bailed out by a group of banks organized by the New York Fed. The moral of the story is, no matter how smart you think you are, you cannot beat the market, any bet you take is still a risk. Markets are not entirely rational, and when there is a panic the computer models don't hold up, and you have to be prepared to weather the storm until it passes.

Thus it is quite ironic, that we are now witnessing much of the same thing going on:

Aug. 15 (Bloomberg) -- Goldman Sachs Group Inc. waived fees to draw investors to its Global Equity Opportunities hedge fund after stock-market losses wiped out $1.4 billion of assets this month, according to a person with direct knowledge of the terms.

New participants won't pay the 2 percent management charge and Goldman will cut its performance fee in half, said the person, who declined to be named because the information is private. The New York-based firm and investors including billionaire Maurice ``Hank'' Greenberg agreed to put $3 billion in the fund earlier this week. Goldman spokesman Lucas van Praag confirmed the terms and declined to comment further.

Goldman, the world's most profitable securities firm and second-largest hedge fund manager, needed capital after stock declines worldwide confounded Global Equity's computer-driven bets and threatened to spur withdrawals. The so-called quantitative fund lost 28 percent of its value this month. Other quant funds, including AQR Capital Management LLC and Highbridge Capital Management LLC, also suffered declines.

Presumably Goldman is full of bright young MBAs who know this even better than I do, but people think it can never happen to them, that they are the exception. Incidently, for a great insight into LTCM I suggest When Genius Failed by Roger Lowenstein.

The Chief in the Paper

Except for the occassional Wanta nuttiness update I haven't been blogging here much, mostly because of the time I spend on Screw Loose Change. We have been getting much more attention over there, with the latest being a cover article in the weekly arts and entertainment newspaper the Phoenix New Times on my co-blogger and I.

Along with co-blogger James Bennett of Seattle and SLC allies such as New York City's Mark "Gravy" Roberts, author of the painstakingly detailed Loose Change Second Edition Viewer Guide, Curley patrols a veritable Mos Eisley cantina of conspiracy mavens, kooky celebs, Holocaust deniers, nutty academics, anti-Semites, aged hippies, delusional twentysomethings, and cynical, Elmer Gantry-like opportunists, all of whom are united in their opposition to the official version of what transpired on September 11, 2001: that 19 al-Qaeda members armed with box-cutters and knives pulled off the most daring and destructive surprise attack on American soil in history.

Initially conceived as a rebuttal to the popular Internet documentary Loose Change, which, after its release in April 2005, helped disseminate these paranoid conspiracy fantasies to their largest audience yet, Screw Loose Change has since become the way station for everyone who is seeking sanity when faced with the wild distortions, half-truths, and outright lies of the 9/11 truth movement.

More Wanta Nuttiness

Christopher Story continues his story telling. Bizarrely he has individual members of the Supreme Court involved:

Bear in mind also that the two International Court of Justice Judges who are supervising this clean-up are joined by Associate Justice of the Supreme Court Sandra Day O’Connor (for the Republican Party) and Associate Justice Ruth Bader Ginsburg (for the Democratic Party). Contrary, therefore, to assertions from British MI5 sources retailed to us last year that ICJ-related arrests could not take place in the United States, the participation of the two US Associate Justices validates relevant ICJ arrest warrants’ application in the United States: hence Dr Alan Greenspan’s incarceration, which immediately followed allegations that Dr Greenspan and others may have inserted a glitch into the codes in mid-June, preventing ‘payment’. It is understood that Dr Greenspan may nevertheless still have a ‘hold harmless’ agreement containing a clause guaranteeing him a Presidential Pardon in the event of his being exposed as implicated in Wantagate (which he has been).

Supreme Court justices of course do not have political affiliations, nor do they supervise such activities. The International Court of Justice, as I have pointed out previously does not handle criminal cases, and thus has no authority to arrest anyone.

Incidently, Alan Greenspan who Story claims was arrested, despite nobody noticing, continues to appear in public:

July 23 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said financial markets are benefiting from a ``one shot'' flow of savings from the developing world that is about half-way over.

Foreign savings have ``created this liquidity we are seeing,'' Greenspan, 81, told the Building Owners and Managers Association's international conference in New York. ``It is not permanent. It is reflective of a one shot thing. I'd say we're about half-way through.''

But other than his story being preposterous, counter to every observable fact, and completely illogical, there is nothing wrong with it...