JPMorganChase: A Derivatives TimeBomb? Market Manipulator?

Zeal Intelligence ^ | 9/7/01 | Adam Hamilton

[NativeNewYorker]

JPM is a highly liquid stock, with highly liquid options and has a great deal of debt outstanding.

There is ample opportunity to attempt to profit by shorting/buying puts on JPM instruments.

[gcruse]

Derivatives may have higher risk....and produce higher return. At least with buying stock and holding it, the most you can lose is the value of the stock when you bought it. But something as simple as selling short can leave you with unlimited losses. For that matter, anyone brave enough to play the commodities without actually being a floor trader, needs the political wherewithal of a Hillary Clinton to keep from having to bail out when prices drop, because you can't afford to weather the storm, even though if you could, you would win. All this is to say that there are no bad derivatives, just hubristic fools with more money than brains.

[Rodney King]

I didn't have the patience to read the whole article, but it is impossible to assess the risk of these positions without knowing what they are.

The vast majority of derivatives are used in risk arbitrage, and many of the derivatives positions offset one another.

[David]

It may not be quite that bad. In fact the total net notional exposure might well be a manageable number because they may be on both sides of the bet in different places. On the other hand, I assume the numbers to demonstrate where their real exposure is are not available.

[Cicero]

If you buy 50 calls, all you stand to lose is your shirt. If you sell 50 puts, your risk of loss is virtually unlimited. Who knows what kind of derivative positions the thousands of traders at JPM may have gotten into?

[gcruse]

I enjoyed the strips (?) where a dividend yielding stock has its yield sold to one guy and the underlying stock to the other guy. Heavy exposure is then accomplished by large margin buying of yield strips. The guy with the stock got its market gain and a fee from the strip holder. He seldom lost, but didn't have that much gain, either. Stability for thee, risk for me. Interesting stuff. There were some stupendous gains. I never heard about the losses, but you know they were out there.

[cactmh]

We just did a case study on the Metallgesellschaft AG debacle. Management screwed up big time. Had they waited it out, they would've done ok. (it was a big cash drain)

[FreedomFarmer]

A rather good article. I suspect it was meant to be a not so subtle warning that the gold derivative game is coming apart at the seams, because of the GATA lawsuit, and the number of burnt investers looking into all the price manipulation information popping out of embarassing places.
Going to have to check into this Zeal website. Maybe gold really will shoot to $30,000 an ounce, as soon as the paper burns.

[habs4ever]

You didn't mention whether JPM is acting as agent or principal in most of its transactions. While off balance sheet finance can seem risky, what with various swaps and the like with differing maturities, it isn't the bank that accepts the risk, its another party.Over the counter options are also very liquid, and banks rarely allow open postions simply because they want to keep their books flat.Do you know much about the trading culture? I ask because this is my field, and very few firms actually risk that much capital, as they tend to hedge and capture the vig.Turnover it the game for them, as they aren't position traders at all.

[meenie]

JPMC probably anticipates it has become too big to fail and is willing to gamble the taxpayers money as well as its own.There is a limit to what manipulation the Fed can do to prop up a bank with this large an exposure without destroying the credibility of our fiat monetary system.

This bank is our monetary system in so many words. So much of the derivatives is used to hedge various foreign exchange and market risks in our world financial system. We talk about world government, we already have a world banking system that dictates that we become world-governed to support the financial system.

[NativeNewYorker]

The split price/yield stock securities were great, but some accounting/tax foolishness put an end to them.

[NativeNewYorker]

the Metallgesellschaft AG debacle

was simply a case of mismatched maturities between their exposure and their hedge.

IIRC, they had way forward oil price exposure, but stoopidly hedged it with short-dated crude oil contracts.

When the spread between the two moved against them, the game was over.

It was the kind of mistake a ROOKIE trader with NO SUPERVISION might make.

[NativeNewYorker]

This is my field too, and the article does not set the seemingly enormous numbers in the context of net exposure.

[getsoutalive]

I doubt JPM's "net exposure" is available to anyone outside the firm and only a few inside.

Yes, these things are probably liquid and hedged to mitigate risk. However, during market dislocations, that liquidity can evaporate quickly and a hedge is only as solid as the party on the other end of that trade.

During normal market conditions, there is generally not a problem. It is when one of those "unpredictable events" comes along that markets can lock up. If the past few months are any indication, it is possible we may see such an event in the not too distant future.

[SongathuSouth]

No one thinks the wizards at Long Term Capital Management were rookie traders. They were the very best at what they did. And their derivative positions were deemed such a threat to the international monetary system that Greenspan got all the big brokerages and bullion banks to coordinate who would bail them out for how much.

Of course this increases moral hazard. Of course this only exacerbates the culture of "too big to fail". Of course it is technically illegal (talk about a violation of anti-trust!). Of course we are in uncharted waters--and anyone who thinks they understand all the risks and ramifications is like a trans-Atlantic sailboat in 1502 without any knowledge of when hurricane season is. The world has simply never been wired together like this before under an umbrella of such complex financial instruments.

As to Freedom Farmer's $30,000 an ounce gold, LOL. GATA thinks the free market price should be $500-600/ounce. The 1980 peak price adjusted for inflation would be around $2,000. I certainly don't see gold hitting that under any circumstances in the near-term.

As those great commercials that have been running during the U.S. Open this year keep saying, "One can't know the future. One can prepare."

[aculeus]

But something as simple as selling short can leave you with unlimited losses.

Yes and when Hillary had her 'Year of Living Dangerously' on the commodities market her very first transaction was to go short on beef futures.

But no one with knowledge of commodities (and the Clintons' ethics) believes she was 'really' trading and 'really' putting her family's net worth on the line.

[NativeNewYorker]

Agree.

After the LTCM debacle, the NY Fed no doubt keeps tabs on both gross and net exposures by large banks.

But the risks going forward - way overbought/overvalued equities, a derivatives market whose complexity and scale is literally unprecedented, a global recession, currency union in Europe, and the inevitable pending retirement of Alan Greenspan - will stress the system in unforeseen ways.

*I* am mostly in cash and AAA munis....

[habs4ever]

Long Term Capital didn't hedge their postions, they were position traders, which is completely different.A hedge should be nothing but an arbitrage, but these guys, like Leeson before them, had open exposure and made one way bets with no exit strategy.Heroes if it works, but if not??

[gcruse]

. GATA thinks the free market price should be $500-600/ounce.

Not to mention those holding out for the return of $50 silver.  It's
been at $4.50 the last five years and shows no sign of going
anywhere.  For comparison it was also $4.50 in the mid-1970s.
Such an investment.