Why I don't dabble in derivatives
Not that I have money for investing in stocks either... This just demonstrates how corrupt the market has gotten.
I'm wondering if the market wouldn't be better off if there were just basic stocks (offering dividends) and bonds (offering flat rate payouts) and we did away with all the other chicanery. What say you?
I'm wondering if the market wouldn't be better off if there were just basic stocks (offering dividends) and bonds (offering flat rate payouts) and we did away with all the other chicanery. What say you?
However, the crisis also demonstrated the dark side of derivatives. First and foremost is counterparty risk. Much of the unraveling of the crisis was due to the failure of counterparties (AIG, Lehman Brothers) daisy chaining through an inextricably intertwined system. People who point to the notatial value of interest rate swaps, credit default swaps, and other over the counter derivatives (now estimated at over $600 trillion) are pooh-poohed because most of those swaps are netted by derivatives dealers against swaps going the other way. The net exposures are small fractions of the gross notational amounts. Unfortunately, when a counterparty fails, the net exposure becomes the gross exposure, and that's what happened last time and will happen again.
The counterparty risk contributes to the other big risk in derivatives: liquidity risk. We saw a couple of weeks ago with ETF pricing the liquidity risk in a product whose reference instruments are regulated and priced on an exchange (ETFs are derivatives; their pricing is derived from the price of a basket of financial instruments or an index). When the SHTF, liquidity dries up, and that is even more so when the products are traded over the counter. The market makers for interest rate swaps (by far the largest OTC derivative) and credit default swaps are the giant banks. As a very small participant in the those markets, when my trading desk tried to institute or unwind positions, we were looking at huge spreads. The market makers have fought tooth-and-nail against measures that would make those markets more transparent, or, by bringing them onto an exchange, more competitive. Now, with Dodd-Frank regulations and the Volker rule, those derivative markets, as well as more mundane bond markets, are even less liquid. When the SHTF this time, it won't be a situation of wide bid-ask spreads, it will be a situation of no market at all.
One final note. Now that I've retired from finance, I do not speculate in derivatives. It was hard enough when I had a Bloomberg machine and other computer systems that gave me virtually instantaneous access to information and markets. You have to be completely on top of it to have any hope of success. Without such systems, speculating in derivatives is a sucker's game. For interest rate and credit default swaps, it requires a multi-million dollar stake just to participate.
Do you recall back in the 1960's (or was it early 70's?) when the Hunt brothers had cornered the market on silver? As I recall the people running the system changed the rules ex post facto so their friends on the losing side of the trades did not actually have to deliver silver.
When the rules can be changed against those of us who are not 'connected' to favor those who are, I want no part of such a market. If you are a particularly astute trader and can see it coming so that you can bail in time more power to you. I'd rather deal with things and people who keep their word.
As you pointed out, who wants to spend their retirement pouring over computer screens every day... ? Easier to enjoy life, and I've always found, easier to control your own business / your own destiny and be certain of the outcomes .
maybe also the dot com bubble? -- j
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(This is not to say that there aren't legal, ethical uses for such instruments, but the rules are designed to allow insiders to manipulate prices and manipulate producers of the real commodities.)
They destroy markets. The excuse that they create liquidity is a smokescreen to protect the guilty and hide their unethical manipulation of markets. They can't profit in a free market, so they manipulate it to steal from others.
I'm not saying you should dabble directly, but you benefit anyway from the high liquidity.
Hedging is reduction of an existing risk, and helps commerce function. Speculation is taking on that risk from hedgers. It is a dependent relationship... hedgers need speculators. The fact that speculation volume can be much larger than the hedgers need just makes a market more efficient.
Hedging is always reduction of risk, like buying insurance. Speculation is always taking on risk.
The meaning of the words are confused in media reports. Like when JP Morgan announced they lost $2bln on a "hedging loss" in 2012, it was worded like that for the regulator's benefit. It would have been less accepted if they said they lost it on a speculation that went wrong.
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What do you think?
Who was it who said, "Sure the game is rigged, but if you don't play, you can't win?"
All of life is chancy. Look at the folks who invested in the making of the "Atlas Shrugged" triple header. If I had that much money, I might well have put it in a pile, sat on the pile with my shotgun and dared someone to try to get any of it. But in another way, my gambling was in start-up businesses. I knew I could rely on myself and my willingness to work hard which made up for the lack of funds. (If you do the work of three, you save the wages of two.).
Derivatives aren't all bad. For instance, a steep put option can handsomely reward someone who steps back from the masses, looks at the fundamentals, and determines that an equity is severely overpriced and due for correction. Similar is the reward of a call option for someone who has uncovered an absolute gem, such as a company which has invented a machine that converts atmospheric static into usable energy.
Figure the amount of years left in your life span plus five or even ten.
Divide the after tax portion by that number.
You will be in one of three catagories.
a. Not enough to make a long term real difference but maybe enough to worry about investing
b. Enough if spread out over the time span and keep working to 66 or whatever it is now.,
c. Enough to quit work immediately
If it's b or c your main concern is protecting your funds. Relatives, friends, commission agents, moochers of all kinds are now your biggest worry. There is no need to invest unless you live in a high inflation economy. In that case move to Mexico - or elsewhere. A zero interest account means no tax consequence each year.
Two kinds of those besides the mattress and one - banks etc. have FDIC max'd at $250,000. Not a place to park a million in lottery net although their are ways through LLC's. The other is zero interest T Bills which means you will still lose to inflation but that's a smaller loss than eventually getting a check for $250,000.
In a nutshell do you NEED to invest. If you already have enough...Why?
Interesting article. Thanks for sharing.
As salta says, I do not think the market would be better off without derivatives. They create liquidity and maybe reduce speculative bubbles by providing an easy vehicle for people to take short positions.