Idle Speculation... Counterparties, Derivatives, and Hedging.

I work with a fellow, incredibly sharp, and very well versed on finance with a focus on hedging.

Today we were talking.

He talks about how basically everybody is hedged in all of these ways, so that they'll be assured of returns within some particular range. For instance, a bank doesn't care about whether you pick a fixed or a variable interest rate, because as soon as they make the deal, they're going to hedge it with derivative deals designed to make sure that returns over the period of the loan are within an acceptable percentage range, irrespective of what happens to actual interest rates over that time. Well, it seems that everything works out great as long as none of the hedging Counterparties go under. At that point, you have to have another layer of hedge to insure you against counterparty bankruptcy. Soon enough, it becomes a pretty ugly web of dependent hedging relationships.

Another example would be in the case where you might write, say, 1000 Naked Call Option Contracts on some company. You don't have the shares, but you've just offered to sell 100,000 shares to the Call Buyers IF the price of the stock is above a particular "strike price." At the Option's Expiration Date, if the Calls ended "in the money," then you'd have to buy and deliver a huge number of shares, and you'd take a very large loss on the deal. Well, to protect from losses, you can simply buy a swap from a counterparty, which basically insures you against loss in the case that you had to deliver shares. Having just paid a premium to a counterparty, however, and by putting THEM on the hook for your potential losses, you are giving that counterparty incentive to support your interest in whatever way they can; to keep your calls "out of the money." Of course, your counterparty isn't going to just go on the hook for your losses without a hedge, so they might very well bring another counterparty in on the deal, and so on. In such a way, there could potentially be incredible amounts of money riding on the success or failure of even a small public company, and nobody outside of the loop would have any way of knowing about it. These side deals would all be private arrangements, and they wouldn't leave a tick on a chart.

Well, my first impulse was to suggest that in such a situation, a share price could not move freely because of all the pressure put on it by its associated Derivatives, but my friend corrected me, and suggested that, no, the shares could move to reflect fundamentals IF the Derivatives were in balance in both directions. Of course, normally there would be Financial interests sitting on the other (long) side of the deal. Some of these interests would be the same ones that were placing the original short bets, and long interest could be used as a hedge in and of itself. However, it's not the normal case that I'm worried about. The case that I'd be worried about would be one in which a significant chunk of Wall Street were on one side of a trade, and they eventually had to take their losses and test the fitness of their counterparties. Really, it wouldn't have to be Call Options in particular, it could be the Derivative Hedging of Short Sales, or Naked Short Sales of a target company, that could create a systematic counterparty risk in the case of a big, unexpected price movement.

Last, imagine that you are at a company involved in Investment in the Stock Market, and you are involved with various and sundry counterparties in hedging deals. Imagine that you look at a stock or industry that seems like a promising prospect for future growth. What would you do if you found that your counterparties would take big losses if you went and did something to drive up the price and profit from the long side? Well, at the very least you'd think very carefully about whether it would be worth it to blow up your own counterparties by buying those shares.

I don't know... it's just Idle Speculation.

New SHO Rules - SEC

http://www.sec.gov/cgi-bin/txt-srch-sec?text=SHO§ion=Entire+Website&sort=rank

Today's Linkage - 8/2/08

Naked Shorting on Fox News

The Mitchell Report - Deep Capture

Independent on Shorting.

The Big Question: What is short selling, and is it a practice that should be stamped out? From the Independent. Found by Zbuxster of Yahoo.

"If all goes according to plan, the investor is paying less to buy back the shares than it received for selling them. There are some costs involved, notably that the lender charges a fee for loaning out its shares, but in an ideal world the shorter still makes a tidy profit.

There's a variation on this theme, known as "naked short selling" – a form of shorting where the investor doesn't even bother to borrow the shares it is betting against. This is possible because share deals are often not settled immediately. The seller promises to deliver the stock after a short delay – say three days. If a short seller buys the stock back before it has to make good on the original delivery, no shares need actually change hands."



Here's something that I haven't really seen discussed.

When a short seller borrows shares from someone, they have to pay interest on those shares.

What happens if a Hedgie Naked Shorts? Who do they pay interest to? I think the answer is "nobody." They don't borrow shares, they pay no interest. This means that there is an actual financial incentive to Naked Short as opposed to sell a Covered Short. It's cheaper to Naked Short.

Really, I'd think that logically, even assuming that naked shorting were legal, that the naked shorter should owe interest to the BUYER of that FTD. Really, it could be said that the person that sold the share, but didn't deliver, is actually borrowing a share from the BUYER.

Misdirection and lies from Barrons - Naked Short Selling.

Barrons on SEC and Short Selling.


Here's an article on Short Selling from the Magazine that added gasoline to the Fire brought to LDK by Charlie Situ.

This is the Magazine that implied that LDK was the next Enron; the same Magazine that put their readers deep underwater in a short position against LDK of Gigantic Proportions.


They consistantly merge "Short Selling" with "Naked Short Selling," to confuse the uninformed reader, and to preemptively counter the SEC's new regulations on Naked Short Selling. If you read enough Wall Street Media articles on this issue you'll see the same thing, over and over. Liers, one and all.


Check out the following statement from Barrons: "Short-sellers read Barron's with special interest, and they also make good sources of information that our reporters can check and publish if true." LOL! I must say, it would better for everyone involved if Barrons actually had checked their facts on LDK prior to sending Waves of Short Attackers after the Company. Hell, even after LDK has been cleared of the charges, I've not sen any indication that Barrons has acted to correct the record.

Barrons has no credibility; they are the FOX News of Investment Media.

Their commercial states that the average portfolio of Barrons Readers is 3.2 Million Dollars. I'll be interested in seeing the updated stats when LDK and Chinese Solar squeezes them the hell out.

Christopher Cox on Naked Shorting and Regulation.

What the SEC Really Did on Short Selling


Excerpts:


"Who profits from intentionally false information in the marketplace? Those who are in on the scam and positioned to benefit from the predictable response of people who believe the fraudulent information to be true.

The classic "pump and dump" scheme, in which a stock is inflated through false information and then dumped on unsuspecting investors when the perpetrators flee, is one example of how this works. "Distort and short" is the same thing in reverse.

"Naked" short selling can turbocharge these "distort and short" schemes. In an ordinary short sale, one borrows a stock and sells it, with the understanding that the loan must be repaid by buying the stock in the market (hopefully at a lower price). But in an abusive naked short transaction, the seller doesn't actually borrow the stock, and fails to deliver it to the buyer. For this reason, naked shorting can allow manipulators to force prices down far lower than would be possible in legitimate short-selling conditions."



"Although the Commission's order was issued under emergency authority in unusual market conditions, it is based on several years of experience and analysis. In 2004, the SEC adopted Regulation SHO to attack the problem of naked shorting. It requires broker-dealers, before they accept short sale orders or effectuate short sales in their own accounts, to first borrow the security to be shorted, or enter into a contract to borrow it.

But Regulation SHO also offers an alternative to these requirements if the broker has "reasonable grounds" to believe that the security can be borrowed. This could create opportunities for evasion of the rule's purpose.

That has led the commission to consider simply eliminating the "reasonable grounds" alternative altogether. This is essentially what the SEC did for the financial firms for which the American taxpayer is now on the line. It is also what the commission is even now considering for the broader market."


---------------


Good stuff. Very hopeful, and Right On in philosophy.

Key Phrase: "Although the Commission's order was issued under emergency authority in unusual market conditions, it is based on several years of experience and analysis."

Note to Cox - Don't Do It.

"``Without a market-maker exemption, I could see this having a profoundly negative impact on the liquidity that would be provided in stock and derivatives,'' said Steve Sosnick, an equity risk manager in Greenwich, Connecticut, for Timber Hill LLC, one of the largest options market makers in the U.S. "

SEC Poised to Exempt Market-Makers From `Naked-Short' Sale Ban

Yeah, now what is he talking about when he talks about liquidity? He's talking about the fact that if this goes through, there might not actually be enough shares of stock to go around. You know what that means folks? It means that prices go up.

That would be TERRIBLE!! Imagine all of those 401k's with their suddenly more valuable shares of stock. JUST IMAGINE!

EDIT: He did it.

Cramer on Manipulation - If you haven't seen it.

Video Here

Selected Quotes:

"It's important when you in that hedge fund mode, is not do do anything that's remotely truthful."

"The fiction is developed, by almost anybody who's down like 2% to up 6% here. You can't take any chances, you can't have the market up any more than it is, if you're up 6%, because starting Jan 2 you'll have all your money come out; so what would you do in that situation and you feel like you're desperate?"

No Comment.

Misdirection by Exxon.

While wind and solar power are expected to grow rapidly, they will account for about 1% of global energy demand by 2030, while 80% of the energy needs will be met by oil and gas, according to Robert C. Olsen, chairman and production director of Exxon Mobil International Ltd. (XOM) Wind and solar power will grow an average of 10.5% a year through 2030, compared with 1.6% average annual growth for coal, gas and oil combined, Olsen estimated. "It will be the conventional energy sources -- oil, natural gas and coal -- that will need to meet the bulk of the world's energy requirements over the coming decades," he commented at the Offshore Europe energy conference in Aberdeen, Scotland.

http://money.cnn.com/news/newsfeeds/articles/djf500/200709041449DOWJONESDJONLINE000590_FORTUNE5.htm

Standard bullshit here.

Prices of many of these technologies are going down RIGHT NOW. Manufacturing of these technologies is ramping up. Early participants have already passed the 1% mark (Germany), and they did so at a premium. Followers will benefit by the investments of the early adopters.

I'd put my target closer to or above 30% by 3030, which includes an explosion in the energy biotech market which is coming within the next three years.

Exxon will buy in, that's for sure, but the last thing they want to do is telegraph future interest.