"they would have had to capture every move perfectly to make
the kind of money they supposedly made"
Not quite, but close enough. They sell options on,
say, equities, according to mathematical models. These models
always make money, except in rare "tail" situations when
the models stop working. They are the market makers. When the
market threatens to go against them and blow them up (LTCM
case), it becomes a SYSTEMIC CRISIS issue, so they go to
the Fed and the Fed gives them all liquidity they want.
This option market then becomes a huge CASINO operation,
in which GS and other MM are the house. Moral Hazard, of
course, cause were it NOT for explicit Fed support, the boyz
would not lever up on these trades, they would blow up
already, as they did in 1987. That was "portfolio insurance".
Put options are absolutely the same thing, dressed up
differently, and guaranteed by the Fed.
This blew up in the bond market due to defaults. It could blow
up in the stock market as well, because there is a huge
disconnect between what is going on in the credit market and
the current levels of stock prices.
For what it's worth, they are NOT gambling to time a perfect
stock market move. Rather, on return to the mean. They
are betting that stock moves around beta are completely
random. They lose in case of a very large move that blows up
volatility. |
