Commercial Real Estate Finance

Llenrock principal and former trader, Dave Weinstein, offers his thoughts regarding recent news about Wall Street’s latest attempt at fleecing the public.

Fed Could Sell Options to Ease Rate Swings, Credit Suisse Says

Assume for a second, you don’t know anything about option pricing.  Then ask yourself, “If I had to make a bet, would I bet that the world is going to become a more volatile place or a less volatile place?”

If you said a less volatile place, congratulations.  As a taxpayer, I’m sure you’ll benefit from the upside of trade outlined in the referenced Bloomberg article.  And, if you believe that, I’ve got a co-op in Manhattan I’d like to sell you.

Are these I-banks a riot, or what?  So, it sounds like clients are buying a lot of options (buying vol) to protect themselves from volatility.  This leaves the dealers with the mirror positions (short vol). i.e. The smart clients who bought the options win if there is more volatility and the I-banks lose.  And, what have we learned from recent events?  Trading positions that might lose money for the banks get laid off on the FED.  So, per this article, the I-banks would simply cover their positions with the FED.

Two problems (at least): 1) consider the source (a recurring theme in these pages).  Why would you want to buy what these guys are selling?  If it is valuable, why do they want to sell it?  To Hedge?  Well, if they bank clients want to buy options and the banks don’t want to sell them, why should we, as tax payers, facilitate the trade?  As a tax payer, I think I’ve had my fill of Wall Street fixed income product, thank you very much.  2) Consider the trading position the Fed would have.  They would be long spot (they have been buying a lot of bonds lately) and short a straddle (short vol).  As the attached graphs show, it basically gives them limited upside and all the downside.  Great trade!!!

Again, you don’t have to be a Wall Street quant to realize that the US tax payer should not be betting against a rise in volatility.  I thought the whole idea of the FED was a US taxpayer hedge AGAINST volatility.