TKO

Barron's Plan to Save the Economy - For Just $200B?

The numbers seem staggering but, step back and think about it for a second. Go back to the basics and think what a derivative is. It is an instrument where value is derived from some other instrument. The numbers you are speaking of are most likely notional/nominal amounts and not actual dollar values of the instruments.

For example, if I were to sell 100, 100 strike april expiry, put option contracts on IBM at a cost of $9/option... I now have a $1,000,000 obligation in few months time if IBM stays below $100 by expiry. All for a $90,000 premium.

So now what, my asset is $90,000 and my liability is $1,000,000? No.

The $1,000,000 is the nominal value but the asset (options) based on time of trade is worth $90,000.

If i close this trade out by buying back the put options before expiry/exercise, I can immediately close out the $1,000,000 nominal amount and book a gain or loss based on the dollar amount that changes hand on the close.

The example above is only of one type - equity options. The nominal/notional value is small in comparison to swaps where the notional is often greater than $100,000,000 per deal.

You can't simply look at the notional value to determine risk. Risk is far more complex than that - in fact, it is a very gray area that brought us into this mess in the first place. We use quantitative theories to arrive at some formula to calculate a number that can be interpreted in some way to determine how risky something is. If everything breaks down as it did in the sub-prime mess, we begin to question the number, the calculation, the formula, and the theories. This uncertain area is what we should be scared about -- NOT the notional values.

On Feb 16 03:25 PM phdinsuntanning wrote:

> buying Venezuelan sovereign bonds
> probably have more hypothesis to end
> the subprime mess. 200 billions are peanuts,
> look at how much is at risk
>
>
> Top of the list remains JP Morgan Chase Bank. It held $91.7 trillion,
> yes, trillion in derivatives in the third quarter of 2007. One year
> later, it held only….$87.7 trillion! A shrinkage of $4 trillion.
> Now, JP Morgan’s assets are only $1.7 trillion in 2008, better than
> the $1.2 trillion they had in 2007. At least one financial institution
> is getting some benefit from the crisis and US government bailouts,
> but with a huge risk.
>
> Bank of America was third in derivative contracts in 2007, now is
> the second. In 2007 its Derivatives were at $32 trillion and in
> 2008 are $38.6 trillion! its assets were $1.2 trillion in 2007 and
> $1.3 trillion in 2008, so they increased their assets in only 100
> billion dollars ( close to the size of the refined copper market),
> but its Derivatives rose by $5.4 trillion. Pretty risky.
>
> Citibank is the third now US bank with more derivative contracts
> and holds $35 trillion in Derivatives, one trillion more that the
> $34 trillion in Derivatives of 2007. With total assets more or less
> unchanged of $1.3 trillion it looks in a pretty risky position to
> me.
>
> thanks Elaine for the data