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Saturday, May 23, 2009

Comments to discuss, 23 May 2009

Fallout of hostility towards bonuses to AIG employees

Comment by Anonymous:

It is also worthwhile to note that the AIG bonuses were contractual obligations of AIG, and that most of the folks who received them were working on a $1 salary, cleaning up after the ones responsible for the mess were fired.

A rapid recovery is unlikely

Comment by JD:

Some differences with your assumptions, though I would agree with the overall conclusion.

The US adminstration will not need to go back to the Senate to ask for more money to recapitalize banks. The original TARP money was created as preference shares. By sleight of accounting, converting these to ordinary shares achieves re-capitilisation. Secondly, the political environment has tilted in what, with hindsight, seems obvious - with Congress claiming that TARP money gives them a right to dictate to TARP banks. This is actually wrong - the US doesn't need to regulate the banks who are drowning, those banks are unlikely to do the same stupid things. It needs to regulate the banks who are now healthy and are going to rush in to do the stupid things that (they believe) made money in the past. However, the practical impact is that US Banks are trying as hard as they can to repay TARP money.

This doesn't fundamentally affect your analysis though, because European banks have not yet taken the writeoffs that they need to, so the basic point remains, sort of - that banks will be undercapitalized.

I fail to see why you think that there isn't the political will to effect bank regulation.

About pt #2, that is the reason for the stimulus package and near zero interest rates. That doesn't neccesarily mean that the economy is going to bounce back right away, just that the point that you make is well understood by policy makers, who are attempting to act against it.

About pt #3, mostly agreed, but my assumption is that the hugely lower factor cost of commodities, especially oil, is going to help.

The big change in the S&P 500 reflects a fundamental change in the pricing of risk (or risk averseness). One has to be wary of drawing conclusions from the price movements. Again, I mostly agree with the statement, but not sure that the conclusion directly follows from that data.

18 May 2009 is the reverse of 17 May 2004

Comment by jumpup:

We were tracking SGX NIFTY all through the morning, and not very surprisingly, the volume turnover was one of the lowest in NSE. To the tunes of 3k crore.

Around 90% which makes around 2700 crores was in FNO and the rest was in cash.

Very canny players could have seen a decisive move if they would have followed the huge 3300 PE activity on Friday. Till the last week, open, 3400PE was the hedge everybody was working on, yet on Friday, masses started becoming increasingly bearish.

On Friday, in a rare phenomenon, although the underlying NIFTY kept on rising,Calls rose, [Smart Money effect] and Puts appreciated as well[partly straddles, partly bearish bias]


  1. It not that rare a phenomenon to see both calls and puts go up in value. Check out option premiums for a stock before earnings (or for a healthcare stock before a drug trial result is announced).

    Btw, a better comparison is to look at implied vols. On Friday, the 3300 PE was indeed expensive at 65% implied vol. The 4000 CE implied vol was less than 50%.

    The 3300 PE at similar 50% vol would have been priced half as much as it was of Fri.

    Nothing extraordinary about it - the puts were in demand (higher volume than for the calls) and were more expensive.

  2. Btw, the shift from 3400 PE to 3300 PE is not that surprising either. The more OTM the put the greater the percentage increase would be. As with any OTM option, people are buying lottery tickets. As implied vol increases due to increased put demand, interest shifts out to comparatively cheaper further OTM options.

  3. Vivek I agree...

    The rise in PE and CE both happen when there is vey low volatility in the mkts. It has surely happened in the past and wil repeat again in the future. No doubt.

    But two things, Friday was not a low volatility day. Secondly, the rise in cost of PE was huge, 30 odd pc though the underlying rose and closed near days high, around 3685 circa.

    And the lottery logic is often a way traders use to form a bias. Smart money was writing ITM PE :D on Friday


  4. Jumpup,

    I don't understand why this would usually happen on low vol days. It may be easier to see variance between implied vol and real vol when real vol is low but that may be all there is to it.

    Increase in puts by 30% when the market is up 2% is not that unusual if implied vol jumps significantly (demand for puts increases) to compensate for the decrease in put value due to the underlying being up.

    Secondly, this is a common thing with options. For example, the earnings in the US have been highly uncertain for the last quarter. One of the common option strategies has been to buy slightly OTM straddles on a stock a week before earnings and sell just before earnings are released. This is a way to buy vol cheap and sell increased vol into earnings without taking on the event risk. Additionally, after earnings the option premia for both calls and puts decreases dramatically (if you factor out the change due to the underlying move) as the event risk is now gone and implied vol is essentially sucked out of the options. So it may not be worth waiting until after the event has occurred to sell the straddle.

    So, yeah smart money would be a buyer of options/vol atleast a week before the event and will always sell into the event sometimes leaving a fraction of the position on as a lottery ticket.


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