I heard from a friend that Goldman Sachs recently put 100 PhDs in a single hall and challenged them to come up with high performing derivatives. Its clear that these folks are going to rip off the common investor. After all trading is a Zero Sum game. A buy and a sell. 

Here is a FT artcile on  Derivatives activity linked to share falls

"The recent sharp falls in stock markets appear to have been exacerbated by an unusual wave of derivatives activity on the part of hedge funds and big banks, traders yesterday indicated.

In particular, some banks and big investors appear to have been forced into selling large amounts of equity futures because they have been acting as counter-parties to large, leveraged bets on the direction of stock market volatility in recent months – and these bets are now unravelling because volatility has increased sharply.

This forced selling has hurt equity futures index prices on markets such as the London International Futures Exchange – and depressed the value of cash equities as well, some observers suggest."

Derivatives which these guys come up with can be mind blowingly complex. Look at the complexity involved in the below OPTIONs transactions

When a dealer sells a put or a call to you, he's gotta go out and sell stock (if he sells a put) or buy stock (if he sells a call). When he does that, he's only hedged in delta-space so long as the spot price does not move.

Now, let's assume the dealer is short a put and sells stock. When the stock price goes down, he's gotta sell more stock to stay hedged (the put delta goes up as stock goes down, therefore I gotta sell more delta against that put you bot). On the other hand, when the stock price goes up, he's gotta buy stock back to stay hedged (the put delta is going down – getting closer to zero – as spot moves up, so he needs to hold less short stock against the put). Either way, when the stock moves, he's gotta sell as the market goes lower and buy as the market goes higher to stay delta neutral (flat). That sort of position is a short gamma position. So you can be short gamma and short delta by being short options (puts or calls, it does not matter, it is all chicken) and having spot move up, and you can be short gamma and long delta by being short options and having spot move down.

Now, what's interesting is that as vol moves up the dealers are getting shorter vega. That means their vega position has 'gamma.' And, as vol moves down, they are getting longer vega. It may make sense to think of a dealer being short a strip of options. And, as strike prices move lower away from spot, that dealer get short more and more options the further you go down. That sort of position would get you shorter more vol and vega as vol goes up and prices move down.

Yes, its sometimes better to invest elsewhere 😉 

Advertisements