in the days of open outcry at times there would be a discrepancy (polite term) between the floor price of say the sp 500 (spooz) and the price on the screen through a data service provided by a vendor to the benefit of the locals (on the floor) and at the expense of the the well heeled off the floor trader
the reality gaps were cured in minutes if not seconds in the world of arbitrage
the screens remain late in the new incarnation of over the counter derivatives conjured in the minds of rocket scientists lured by ignoble riches
simply, a bet against mortgages tied to regional malls (the thinking is that tenants will flee because of online commerce and delivery, a thinking that is well grounded) goes something like this:
buy the credit default swap (a bet against the mortgages or insurance against the mortgage default) and buy the index of mortgages (over the counter and not on an exchange). the bet is that the spread (basis points over the index) will go up (100-200 for example) because as the expectation of defaults on the mortgage and actual defaults ensue the cost of the insurance will go up faster than the value of the bonds will go down, or the spreads will widen
the challenge is the exit or the mark to market. exchange traded instruments by and large are subject to price discovery determined by the market (many) while over the counter derivative trades are determined by the mark to model of the counterparty (big banks model against the customers model or expectation)
the trade may well move favorably but entry price (of say 100) remains steady so unwinding or recognizing any gain either mark to market or realized is not possible because the counter party (big bank) refuses to recognize the changed world (and because it is on the other side of a losing trade)
the screens are late
the reality gaps were cured in minutes if not seconds in the world of arbitrage
the screens remain late in the new incarnation of over the counter derivatives conjured in the minds of rocket scientists lured by ignoble riches
simply, a bet against mortgages tied to regional malls (the thinking is that tenants will flee because of online commerce and delivery, a thinking that is well grounded) goes something like this:
buy the credit default swap (a bet against the mortgages or insurance against the mortgage default) and buy the index of mortgages (over the counter and not on an exchange). the bet is that the spread (basis points over the index) will go up (100-200 for example) because as the expectation of defaults on the mortgage and actual defaults ensue the cost of the insurance will go up faster than the value of the bonds will go down, or the spreads will widen
the challenge is the exit or the mark to market. exchange traded instruments by and large are subject to price discovery determined by the market (many) while over the counter derivative trades are determined by the mark to model of the counterparty (big banks model against the customers model or expectation)
the trade may well move favorably but entry price (of say 100) remains steady so unwinding or recognizing any gain either mark to market or realized is not possible because the counter party (big bank) refuses to recognize the changed world (and because it is on the other side of a losing trade)
the screens are late
Comments