Friday, May 19, 2006

 

Derivatives Behind Market Volatility: FT

The Financial Times reports on what may be behind recent stock moves. "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 is an incredibly sensitive topic but it looks as if some big investors are being forced into big moves because they need to hedge these [derivatives] positions,' one senior trader said yesterday. It is impossible to track this type of derivatives trading with accuracy, since the investors and banks engaged in these markets are extremely anxious to keep their positions private."

"One factor that suggests the market is experiencing some unusual dislocations is that in recent days there have been large price gyrations in European equity futures market after 4pm each day. This is the time when many banks and other large investors reassess their trading positions, and then rebalance their books by buying or selling assets."

"'These market movements could just be programme selling, but the timing suggests that something elseis going on,' said a senior derivatives trader at a leading bank. The issue that is believed to be triggering this turmoil is an instrument called a 'variance swap.' This is a type of derivative that has become very popular among hedge funds in recent months, since it allows them to place bets on the direction of stock market volatility in a leveraged manner."

"The banks that have been writing the derivatives contracts with these hedge funds have apparently been trying to hedge these positions by making large trades in conventional equity options."

"Some observers believe that these movements are temporary, and will quickly correct themselves after a few days. However, others argue that the self-reinforcing nature of these trends could create serious market problems in the coming days, particularly since there are relatively few investors willing to take the other side of these positions at present."

The New York Times. "'Many investors have taken large positions in stocks and they are getting spooked,' said James Glassman, senior United States economist for J. P. Morgan Chase & Company. 'These investors are often hedge funds and foreigners, and if the Fed is going to raise rates more than they thought, that makes it less attractive for them to hold onto their big positions.'"

"Indeed, the sudden unwinding in the market began on May 11, the day after Fed policy makers raised interest rates another quarter-point, to 5 percent, and left open the prospect that more interest rate increases 'might yet be needed to address inflation risks.'"

Comments:
PMs hammered again.

"This is a test; this is only a test."
 
Thanks Ben! One day I'll subscribe to your services!
 
Bloomberg: Commodities, Led by Metals, Face Biggest Weekly Drop Since 1980

``The speculators are piling out of the metals,'' said James Vail, who manages $700 million in natural-resource stocks at ING Investments LLC in New York. ``There's been so much money made in this sector that people are trying to protect themselves. There was skepticism on the upside, and now there's panic on the downside.''
 
Shaking out the weak hands, aka, a buying opportunity.

The metals were so far above the 200DMA it was bound to happen sometime. Meanwhile, the fundamentals continue to improve.
 
Getting out of metals ... into what? Cash? Equities?

Talk about volatility...
 
"``They're not getting long on gold at $700, and copper at $8,200 in London just seems a little too rich. Everyone wants to see a pullback because they want to get back into the market.''"


What a day trading mentality...
 
What a day trading mentality...

You said it! It's the era of instant gratification.

I don't expect to cash in my PMs for years...
 
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