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More Details On The Structured Notes Bubble
A few days ago, IRA's Chris Whalen had a good summary of why and how the next bubble is currently brewing in the Structured Notes space. For those unfamiliar with this particular product, we present a recent Bloomberg brief on the Structured Note market which has quietly grown from a side freakshow into the prime time spectacle. In brief - there has been $25.85 billion in YTD structured note issuance, and over $60 billion in global interest-linked note volumes. An amusing excerpt from the brief: "Sales of notes linked to wheat jumped this month after Russia’s worst drought in 50 years spurred a surge in the price of futures contracts on the grain. Banks including DZ Bank AG and Royal Bank of Scotland Group Plc, issued 82 wheat-linked warrants this month, compared with a total of 159 in the first seven months of the year, according to data compiled by Scoach, the structured products trading platform run by Deutsche Boerse AG and Switzerland’s SWX Group. The listed notes, called knock-out warrants, offer investors a leveraged way to bet on the price of wheat." For all those who thought Wall Street was dormant in the post-CDO implosion vacuum, this is a rough wake up call - it appears no matter what, idiots and their money are promptly parted, and the world's foremost financial innovators will always find a way (and a product) to guarantee that. And it is very refreshing to see that Germany's DZ Bank has almost learned from the CDO bubble: the questionably solvent German bank dominates the Structured Note market with $7.2 billion in issuance to date, followed closely by such stalwarts of financial stability as Barclays and Deutsche Bank.
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"...a leveraged way to bet on the price of wheat." Wonderful...
But structured notes are nothing new. Goldman and others were offering them in size before the 2008 credit market crash. They offer you a "note" tied to most anything and they hedge the risk away with options, futures or whatever. The bad news is you pay their hedging costs, whether you know it or not; and should you want to sell before maturity, well, bend over.
I expect this market slowed/stopped post-crash. So it is nice to know there is a new bunch of 20-something, model-faithful nerds cranking out this crap again.
There are so may thoughtful views of the derviative world on ZH. And they all remind me of the big bang tail risk of the $50 trillion+ derivatives market lurking in the background.
This will immediately expose my ignorance, but what instruments are available to the individual investor to ride this up and (more importantly) back down?
Short the XLF, or regionals. As if there is much meat left on the bones...
So in other words, I gotta git me some of this?
the products mentioned above can be bought by retail investors... at least i can as a german citizen
german grandmas bought that crap issued by lehman - and guess what: they lost everything.
put some smooth words like "safety", "guarantee", "bonus" on your product and you can sell them virtually anything. note: avoid the word "stock" cause they're freakin' risky.
Exactly, "put some smooth words" like Bearns Stearns did with these two funds:
Bear Stearns High-Grade Structured Credit Fund and the High-Grade Structured Credit Enhanced Leverage Fund.
http://www.investopedia.com/articles/07/bear-stearns-collapse.asp
http://www.businessweek.com/bwdaily/dnflash/content/jun2007/db20070612_7...
For wheat and German banks, it would be the ChowDown Wheaties Breakfast-of-Champions USDA-Guaranteed-Safe German-banks-uber-alles Knock-Out-Your-Neighbors Structured Note with Bonus Euro Leveraged Warrant.
And not one criminal has been charged and convicted. No wonder retail has abandoned the stock market.
Ahhh, gentlemen, its bonuses all around.
"knock out" warrants - reminds me of WPPSS (woops) bonds! LOL
haven't seen a reference to those beauties in a while (orange county anyone?).
Theyre going to speculate the price of wheat right out of my mouth, literally.
Nothing will stop the casino from making new casino chips.
I'm predicting that these ultra-low interest rates are going to foment fantastic speculations in the next 12 - 18 months.
Sooner.
Vert good call - it's already happening. Investors searching for yield are buying structured notes where they can make 6% in 6 months, and they sell a downside put option. Perfectly safe.......
None of this is new to any equity trader outside the US. The US market has been small for years but the note business has been huge globally. What we are seeing now is US demand because of the lack of faith in simply being long the stock market. US investors just grew up and moved from the slot machines to the blackjack table.
EDIT - just saw a perfect example in the doc above:
So 'investors' are long a 5 times a 100-108 call spread, short a 100 put, expiry say Sep2012 on the FTSE. Price those options at your broker. Hell, price them on the SPX its going to be similar. You can work out what HSBC actually made. Hint - its not 50bps.
You probably already know that ZH was mentioned in this article.
http://www.thestreet.com/story/10835851/1/hindenburg-omen-is-a-stock-mar...
i saw that. zh is famous now fer shure!
This is a great observation. Included in this bubble are the over the counter swaps populating ETFs, crowded by investors looking for exposure to the underlying asset class, as opposed to counter party risk.
http://bit.ly/bx82HD
So all the trillions pumped into liquidity is doing what ? Oh, yeah, more of the same. Financial engineering designed to trickfuck savers out of their money.
Thanks Barry, for serving Dubya's third term.
Watch soybeans as well.
The size of knock out warrant books in German banks has to be seen to be believed. They are quite capable of detonating a bank's balance sheet, and arguably did so in places like Commerzbank in 2008; its just that the losses there were dwarfed by the really big stuff elsewhere, so noone really paid attention.
DZ Bank is 6th largest bank in Germany, according to Wiki. I suspect it may actually be higher up, since the Landesbanken have shrunk. Go on boys, no risk, no fun, eh ?
At least the equity is not directly quoted, its owned by credit unions and cooperative banks. So they must be thrilled. Imagine if all those knock out products get well, knocked out and the price of wheat keeps plunging ? They'll all be farmers again ;-)
The Farm community is overjoyed that speculators are rushing to fill their coffers with cash, the PHD strutures of such tripe will dynamically hedge themselves into oblivian once again - who the fuk is in charge?
Is there NOT a derivatives market in existence which is several orders of magnitude LARGER than the underlier?
When the tail wags the dog in stocks, paper prices go up, nobody cares. When the tail wags the commodities markets, people can STARVE.
Alot of these products offer attractive interest rates that brokers use to sell to clients "hey, unless something crazy happens this is a huge yield you can't get anywhere else!"
Of course they don't mention the 100-300bps sales charges they get for selling these products that they don't even understand (illegal) to clients who definitely don't understand!
haha, yeah. unless something crazy like one stock out of a basket performs weaker than the others..
"idiots and their money are promptly parted"
Taxpayers who fund bailouts?
I never understood why people bought these things. These are theoretically for sophisticated investors, but a sophisticated investors could easily reverse engineer and create an equivalent risk profile far more cheaply. Sometimes, the buyer is desperate for a bond like investment that gives the possibility of a 10% plus return, and underweights the probability of the downside. The nasty secret is that far too often the "buyer" is managing someone else's money and is getting a slice of the profit one way or another. The market is incredibly corrupt and totally underregulated. In almost all cases, the buyer is actually selling very cheap out of the money options (i.e. actually short vol), and this is why banks love to push this crap.
Then...
You got it! That's about the best answer there is. Desperate investors. Have you met Leo? He knows a lot about pensions, and pensions are more desperate than most. They also have regulations about how much can be invested in equity. Structured notes linked to equity look like bonds to a regulator but can make you 10% quickly. Now you see where the demand comes from? How desperate do you have to be to sell 60% strike puts?
Corruption exists in these markets but only really in Southern Europe and Asia that I know of, and name me a market that isnt corrupt in those parts of the world.
Yes it is unregulated. However, there are a lot of lawyers involved...
You guys worry too much. The theory behind structured notes is neither new or necessarily risky.
Basically, it comes down to what you are 'guaranteeing'. For instance a note that has a 5yr maturity and returns 80% of the S&P 500 if it is up at maturity or par if the S&P is lower at maturity is very safe.
1. You take the initial principal and spend 80% of it buying 5yr zeroes.
2. You buy options and futures with the rest (20% cash leftover).
3. 5 years later the 'zeroes' are at par...so you can return par to the client if the S&P is down.
4. The leverage of the futures/options allows you to get 80% of the gain.
It really couldn't be simpler...I don't know what everyone is so worried about...so the dealers made a point or 2 on the structure and all the phat loot on the contracts, they are providing a service, almost God's work.
Oh wait, one more thing. YOU HAVE TO BUY THE SOVEREIGN ZEROS!!! and NOT do what Lehman did by issuing the full faith and credit of Lehman Bros against the principal, use the cash on your balance sheet, and then go under making all of the structured notes they issued to retail clients at Fidelity and Schwab worthless...
What could go wrong? I'm sure all of the TBTF bastages are doing it the right way now. They would never take that risk again and put the US taxpayer holding the bag.
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