Tuesday, May 11, 2010

Systemic Risk in the Market

From guest blogger Jonas Miller at
Ticker House.Com....

There will be no charts this week. There will be no picks or guidance on commodities. There will only be this. I have voiced my concerns over the interconnectivity of the global financial marketplace for quite some time. On Thursday, we were reminded again that a system so complex and interconnected is doomed to fail at times. Even worse when they are interconnected yet following different rules, guidelines and requirements for trading the same securities and/or vehicles.

My friend who knows nothing about stocks or commodities told me has shares of UCO and GLD because he hears that commodities are a good investment. This shouldn’t happen! With the invention of ETF’s and ETN’s the market has not only exponentially increased its complexity but has increased the danger of market crashes by allowing participants who have no business trading in certain markets access without the cost of risk associated with it. The risk is thereby transferred throughout the system for the simple purpose of transactions…

I was supposed to write some stories on the moves last week. But after reading Barron’s, The Financial Times and the Economist over the weekend and today, I’d be repeating what has already been said. A couple weeks back I posted a small blurb about the systemic risk in the market place caused by ETF’s. In what world does an ETF gain 230% intraday (Think SKF and SRS during the peak of crisis)? Levered ETF’s just exacerbate the problem further by using swaps and futures to gain the 200% move of the underlying holdings. I also warned that an un-orderly mass liquidation of global assets will freeze the financial system solid! And it will…Thursday my fears were confirmed!

Last week’s hellish moves shouldn’t have happened! There is no reason for One Trillion dollars of market value be “taken” from the system for any reason let alone a computer glitch, human error or the combination of them both. One has to wonder if this is what occurred on late 2008. It felt the same at the open, it felt the same right before the crash and it occurred almost the same way. I was short via calls on the VIX and the VIX rallied over 90% last-week. I also voiced my concerns about the complacency in the marketplace and that for the VIX to trade under $20 is simply a mispricing of risk in the system that will correct….and it did!

I am a bit concerned about the state of the global markets right now. That goes for all of them. Equities, currencies, commodities and everything else because they are ALL connected somehow. It wasn’t until the point was raised that Greece might have as much systemic risk (in terms of the complexity not size) as the Lehman failure in 2008 that the EU finally gave in to bailing out Greece and any other Euro zone member who may need funding to avoid default and ponied up a cool Trill to do it! Fact is the bailout will not work…the math isn’t there and regardless of what they may think it will be much harder to shake the wolves and speculators from shorting the EUR and buying CDS against their debt. The market is up 400 points today and I have no conviction whatsoever that it will hold…

Time will tell…I would like to go more into detail on the subject but unfortunately I haven’t the time, Volatility is back in the market and nimble is the word. Sell it when it is high and buy it when its low (relatively speaking).

My next few articles will be on the practice of bidding on options using the Black-Sholes model. Legging into trades. Trading the Greeks (again not those Greeks) and trading the Greeks....YES THOSE GREEKS!

Check out more great articles from the staff at Ticker House.Com


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