What is the economic purpose of put and call options?

[Tysonboss1]

those loans that Tysonboss takes out to invest in his properties - I wonder how the interest rate risk is managed by the provider to enable them to provide the loan?

I heard an interesting fact today, During the GFC $2 Trillion worth of credit default swaps purchased were purchased over and above the actuall debt they were insuring,

Thats like having 5 houses on an island, but having 10 hurricane insurance policies bought.

The analyst talking said alot of the credit default swaps that caused aig to flounder were not even held by people that owned the debt and needed to insure it in the first place.

As I said no judgement here, just trying to understand how it all works, and where I fit in.

 

[cutz]

Thats like having 5 houses on an island, but having 10 hurricane insurance policies bought.

That's like owning no stock but loading up on WOTM long index puts.

 

[village idiot]

hey vi, if I read that last bit of the post correctly - insto's and MM are likely to be net short so unlikely for pinning because of dynamic hedging?

Originally edited my post because I was going to discuss about some funds that build trading [algos] around the expiration dates and other players re-balancing. Basically some are conceptually short the atm straddle on expiration [as part of vol arb engine] - in this case, they would like the atm strike pinned.

mazza, just to clear up what i meant;

1) yes, i was suggesting the MM and institutions would be more likely to be net short, which you seem to be somehat agreeing with? Indeed an effective short straddle was what i was thinking of re the delta hedging

2) I can obviously see why they would like it pinned to the ATM strike,but...

3) delta hedging a short straddle would tend to help push the price away from the strike, not towards it, so..

4) therefore if the big boys are net short and if there is some tendancy for the price to be pinned, it wouldnt be because of delta hedging .

I am not stating this as a fact, more as an "I dont understand this logic", so happy to be educated as usual......


but i am certainly not on the side of the conspiricy theorists; as stated in post 11 , I dont see anything suggesting manipulation here

 

[mazzatelli]

mazza, just to clear up what i meant;

1) yes, i was suggesting the MM and institutions would be more likely to be net short, which you seem to be somehat agreeing with? Indeed an effective short straddle was what i was thinking of re the delta hedging

2) I can obviously see why they would like it pinned to the ATM strike,but...

3) delta hedging a short straddle would tend to help push the price away from the strike, not towards it, so..

4) therefore if the big boys are net short and if there is some tendency for the price to be pinned, it wouldn't be because of delta hedging .

Ah my apologies, I've discussed desirability for pinning instead effect of dynamic hedging on pinning. Yes, you're correct - delta hedging net long ops, will more likely result in pinning.

The example I gave, its part of an expiry correlation arb, while short vol in say indexes, they are long vol in the index components - so not exactly short premium bias if their net position is considered. In this case you'd might see some effects of pinning in the long vol components [topical on strike and size], but not index (as far as I understand they do not dynamically hedge this side of the arb).

So you can see its difficult to discern the inventory and generally categorize who is net long/short- but as Wayne has outlined retailers and funds are in CC's (sell-side long), but there's put buyers (sell-side short) as well as vol/skew-arb funds (sell-side could be net long) etc.

 

[mazzatelli]

I heard an interesting fact today, During the GFC $2 Trillion worth of credit default swaps purchased were purchased over and above the actual debt they were insuring,

Thats like having 5 houses on an island, but having 10 hurricane insurance policies bought.

The analyst talking said a lot of the credit default swaps that caused AIG to flounder were not even held by people that owned the debt and needed to insure it in the first place.

As I said no judgment here, just trying to understand how it all works, and where I fit in.

Well:
1) swaps don't have they same payoff/convexity as options - so is this thread becoming a "What is the economic purpose of derivatives?" thread?

2) I initially outlined interest rate risk, whereas CDS is meant for credit/default risk - so I'm inferring interest rate options, swaptions to manage this mismatch in providing you a long term loan, while their funds come from short term sources.

3) Yes, there was speculation going on with CDS - scenario you're outlining is naked CDS's. imo its the use and regulations around CDS's (OTC, disclosure) that is/was the problem rather than the derivative structure itself. There's also the issue of them being priced with little risk of default (used with mbs) - no one thought the housing market would decline. It's like pricing options today with a flat vol skew.

4) E.g in the energy space hedging solutions solutions are custom designed for producers and consumers of e.g. oil and natural gas - taking into account their risk profile and production/consumption schedule (logistics->refining->distribution).

You're part in all this? It would be minor. I am not saying there isn't speculation using derivatives, but selling equity calls/puts is so basic and minuscule compared to use of derivatives in the much larger interest rate and energy markets.

 

[village idiot]

Ah my apologies, I've discussed desirability for pinning instead effect of dynamic hedging on pinning. Yes, you're correct - delta hedging net long ops, will more likely result in pinning.

The example I gave, its part of an expiry correlation arb, while short vol in say indexes, they are long vol in the index components - so not exactly short premium bias if their net position is considered. In this case you'd might see some effects of pinning in the long vol components [topical on strike and size], but not index (as far as I understand they do not dynamically hedge this side of the arb).

So you can see its difficult to discern the inventory and generally categorize who is net long/short- but as Wayne has outlined retailers and funds are in CC's (sell-side long), but there's put buyers (sell-side short) as well as vol/skew-arb funds (sell-side could be net long) etc.

Ok, that makes some sense, thanks. another piece of the jigsaw....