Hedge Hog

Dr. John C. Hull is a financial engineer, and has written a nice Tome on Options, Futures, and Other Derivatives. It is up to the 9th edition these days. Sigh. I only have the 8th Edition. What's a girl to do?

Dr. Hull outlines the most famous Hedge blowups in one of the chapters of each of his editions. LTCM. Metalgesselschaft. The new one likely has MF Global where the huge futures brokerage got slammed in a pickle hedging Spanish and Italian Bonds.

While these all were not due to Breaking the Hedges by taking the hedge off temporarily to speculate on a movement one way or the other, Dr. Hull says that breaking the hedge to speculate has been behind some of the more spectacular hedge blowups in history. In the case of MF Global, it was an imperfect hedge of European Bonds of indebted countries that behaved more like a speculative pairs trade. To be a perfect hedge, the pairs must move nearly exactly opposite like the Australian Dollar Calendar hedge shown earlier. Here is a Canadian Backwardation memory refresher for you... with thanks to Thinkorswim Paper Money at that same CME...

Colour me guilty. I broke the hedge after being T-Boned by a banker in a Blue Tec during our last Mercedes Demo derby day. It wasn't on a currency... I'm not Crazy! I unbalanced my pet hedge, taking a calculated risk, going long where I should have been short.

I pick my poisons carefully. This one went down a bunch at first, but if you grit your teeth and hold it long enough, it will come back. Plus my pockets are deeper than a Wall Street Ho's! I'm sorry. It won't happen again. (Fingers crossed behind back)

Anyways, talking about calculated risks, Brokerages tend to say that short positions are dangerous! That is especially ironic because Brokerages are short of Everything! "You could lose everything if the stock goes up!" they say. Now think about that for a second. When was the last time you heard of a stock going to infinity versus the last time you heard of a stock going to zero (think MF Global)?

 Another thing about being short is that you have the cash in hand. Of course they take about triple the buying power to hold a short position, and will demand that you close out some of the position if the underlying security becomes hard to borrow. They like to keep those for themselves, so they make it hard for you to hold those shorts. They don't care if you have them hedged where you are getting what ever they gained back on the other half of the portfolio.

Note this presents a second paradox and an arbitration opportunity if you stretch it even further. You will have to figure that one out yourself though. We do not have to show you our cards even though the broker looks at them through his glass poker table.

The truth of the matter is that stocks go off market lots. Mining stocks are one example. Volatility tracking ETF's are another that have to be rebalanced all the time to keep from going off the market. Think UVXY, TVIX, VXX. It is almost a sure thing!

Close enough for me! Teehehehe!