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Strategies & Market Trends : Systems, Strategies and Resources for Trading Futures

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To: TradeOfTheDay who wrote (6081)	10/10/1998 2:09:00 PM
From: Tom Trader	Read Replies (3) of 44573

Bev--thanks for the link -- very interesting article Let me offer you a general commentary regarding last week's events I have been trading the bonds for almost as long as I have the spoos --15+ years--and the currencies for a year or two less. I have never seen the bonds reverse as sharply as they did this week -- under normal circumstances such a move would be reflective of a major top -- but it is usually triggered by a fundamental event that suggests that rates are headed higher. This does not appear to be the case here since the general consensus is that rates are headed lower--with a slowing economy, zero inflation, etc. The decline in the dollar over a few days has also been dramatic--and that it has happened against the yen when all we hear is that Japan is a basket case with negative growth, etc, is all the more surprising. Now the US is not without its problems as well with the burgeoning trade deficit. So what we have are external events -- namely the unwinding of hedge fund positions -- causing dramatic moves in the bond and currency markets--and when I say dramatic, I really mean it in every sense of the word. Now the frightening thing about this is that I don't think that anyone really knows the magnitude of exposure that exists--what we do know is that if/when there is major exposure the unwinding can cause very exaggerated moves in any market. And therein lies the significance of the article for which you provided the link--we are talking massive leverage -- so massive that it is almost beyond comprehension. The 87 crash was believed to have been caused/exaggerated by portfolio insurance. If we have a crash this time around, it will be the leverage as it relates to the hedge funds--and the unwinding of positions. As I posted before, LTCM is supposed to have had $1.25 trillion dollars of positions in various markets--and that is one fund, albeit the largest. We know what happens when there are margin calls by brokerages against individual investors and how that affects the markets. Now think of the impact on the markets -- and particularly, the stock market--if there were demands on these funds to liquidate positions. The article is absolutely right that the leverage that presently exists probably exceeds that in '29 when one could buy stocks with 10% margin. All of the above is not an attempt to scare anyone or to paint a doomsday scenario--because the two unknowns are how much exposure there really is in terms of the stock market with these funds and whether liquidation of the positions can be done in an orderly manner. What we do know based on anecdotal information as well as the action in the bond and currency markets last week is that absent an orderly liquidation, one can have tremendous/exaggerated movement and if it is to the downside who knows how far and fast it could move. Coug makes some good points regarding LTCM; I find it ironical that even as the US lectures Japan about how it needs to let banks that are insolvent/mismanaged go under, the Fed organizes a rescue of a fund whose sole goal was to provide high returns through highly speculative leveraged investments. I guess what's good for the goose is not always good for the gander!! Even if one argues that the rescue was an imperative in terms of the effect that it would otherwise have had on the world markets, it is ludicrous that the rescue package--as I understand it-- not only allowed Merriwether to continue to be stay and manage the fund but also would enable deferred management fees to be paid to him and his cohorts. What am I doing given all of this?? Staying very flexible in terms of any positions that I take. Am mostly in cash and t-bills and have core positions fully protected lest there be a crash. Now if hedge fund exposure is not a problem in relation to the stock market or there is orderly unwinding of positions, then the downside is probably limited. As for next week--I am long as you know--in terms of trading positions. I have decided that with a week to go, I'll probably just keep all Oct OEX positions/spreads as is and let them settle for cash--because I'll come out ahead no matter what happens. When I sell naked OEX calls into strength next week, I'll do it using the November series. Hope that all of the above makes some sense. Have a good weekend.

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