Greed Is Still Good (Though Not In All Its Forms)

by: Cam Hui, CFA

I received this picture in my email inbox, titled I finally got the Christmas lights up last night. While amusing, this seems to be a metaphor for how Wall Street behaves these days: All sizzle and no steak.

No contrition at all
After the recent train wreck in the world financial markets, you would think Wall Street would be a little bit contrite and be more careful about what kinds of products gets pushed. Apparently, they are only paying lip service to that concept. I encountered this article last week, indicating that bankers were selling FX-based structured products as places to park short-term funds[emphasis mine]:

Clients in the private bank space are already starting to trade some of the new ideas. Amanti says that BarCap is marketing ideas that take advantage of the increased volatility, which is at unusually high levels. Typically, currencies don't move much, but today the volatility on many currency pairs is similar to the vol levels on equities a year ago. Even at those levels, it is still possible to take advantage by using, for example, products that offer a very large range around a spot level or that take a view that the spot will not move as much as the volatility implies.

"Also, given the current high volatility environment, the idea of selling volatility, either within capital protected structures or taking some principal risk, can be very attractive and these ideas are gaining more and more traction," says Amanti.

They are now getting clients to sell volatility to enhance returns? Do these “sophisticated” clients understand the risks, like they understood the risks with the CDO and CDS markets? There are many good discussions of volatility, David Merkel at The Aleph Blog is a good example:

Implied volatility estimates as applied to option pricing formulas are a fall-out. No one thinks they are true, but they are a paramater used to keep relationships stable across options of similar expirations.

Intelligent hedgers hedge options with options; they don’t try to apply the theoretical equivalence that lies behind the traditional Black-Scholes formula and do dynamic hedging with the common stock itself.

Do these bankers have no shame? Having bankrupted little municipalities in Ohio and elsewhere, bankers are now looking for new suckers?

Greed is still Good.