When someone buys index futures, he buys them from a market
maker, who then enters a futures short position and a long
position in the cash market (buys actual shares of SP500
stocks) to offset the short for a neutral
position. Market arbitrage is completely automatic, so robots
do that and cause big 1-min spikes that have occurred
frequently during the past 3-4 years. Many bears claim this
is a single entity (990N), such as a Fed money center
bank (JPM?), which then has direct access to unlimited money
supply from the Fed. A more natural explanation would be that
LTCM-type programs have become extremely popular on Wall
Street in recent years, so a lot of hedge funds and WS firms
are selling delta-hedged options for income. The fact that
so many are using the same programs leads to fast spikes in
the indexes, as there are the quick and the dead in the
bunch. Now, this stuff is really somewhat tweaked programs
that LTCM used. The early version was portfolio insurance in
1987. This stuff really causes market crashes when liquidity
dries up. Thus, the Fed must ensure it does not, and they do.
That's the game in a nutshell, but I feel the game may have
grown much bigger than the Fed, which, in turn, would mean
the Fed can't stop the crash that would occur most naturally
if those games were played without the Fed. While stocks
appear important, most of these games are being played in
currencies (the carry trade), so whenever you see Yen rally,
stocks start crashing. You have to see the moral hazard part
of the game - since the Fed always provides liquidity at
critical times, the game has become "risk free". Money for
nothing, chicks for free. Just lever up your positions and
earn 30-50% per year in "income" selling options on stocks
and currencies. No more
LTCM crashes or 1987. The fear is that the game grew to be a
lot bigger than the Fed in recent years, so the Fed can do
nothing to stop the natural crashing tendencies it exhibits.
At some point a crash has to be the guaranteed outcome of the
mess. |
