5 ms·

Completely silly to put in the notional value of the derivatives market in there as most derivatives are designed and issued in a way such as the real value is

by chvid 6y ago

Completely silly to put in the notional value of the derivatives market in there as most derivatives are designed and issued in a way such as the real value is none or cancelled out.

ggrrhh_ta 6y ago
Can you elaborate on that? (Genuinely curious)
- quickthrowman 6y ago
  For stock options, a vertical spread is a combination of buying and selling a put or a call. I could buy an AMZN call expiring next Friday with a notional value of $300,000 (100 shares at 3000 strike) for $6,250. I could simultaneously sell an AMZN call with a notional value of $300,500 (100 shares at $3005) for $5,855. My net debit would be $395 with a max profit of $105 if AMZN closes above $3005 a share at expiration. In the above I bought a call from someone with a notional value of $300,000 and someone else bought a call from me with a $300,500 notional value. I paid $395 for this setup that has a notional value of $600,500, but the most I could ever get back is $500, the spread between the strike prices.
  - ggrrhh_ta 6y ago
    Many thanks, I think I can now understand the initial comment; in the derivatives market, the underlying value is decoupled from the actual money value of the transaction, and the latter is negligible with respect to the notional value.
- seanhunter 6y ago
  Some examples: 1. Futures are contracts agreeing to buy or sell some underlying asset at a future date (or exchange cash as though you did). If I am long a future someone is by definition short that future. Therefore the total net exposure is always zero. It makes no sense to add my long future to your short future and decide that the total exposure is 2. 2. Swaps are contracts where we agree to exchange cashflows based on some reference amount. The most common types of swaps are interest rate swaps and an example might be a fixed-for-floating swap where you agree to pay me fixed interest (say 4%) and I agree to pay you floating interest (say 3 mounth USD LIBOR plus 200bps). The notional of a swap is the amount we use for the calculation of this interest payment. It really isn't an amount that's used for anything else - you don't owe me the notional and neither do I owe you that. It's just a multiplier we use when we transfer the net difference between the two rates. It therefore makes no sense whatsoever to add up the notional of swaps contracts. Also since we exchange the net difference the notional can be pretty large and the net cash payments pretty small. 3. Credit default swaps are similar to IR swaps except one of the legs of the swap pays out based on certain "credit events" (typically defaults and/or downgrades) on an underlying "reference obligation" (usually a corporate or sovereign bond, but can be an ABS or probably some other stuff). Since different CDSs are based on different underlying reference obligations, adding up notionals of different CDSs makes as much sense as if I say I have 10 dollars, 2 matchsticks, a ball of fluff, a ferarri and a dog so you say I have 15 things. Well I suppose so but it doesn't really mean anything since the things themselves are very different in nature.
RobertoG 6y ago
It's also problematic to put public debt in the same bucket that private debt. Those are very different things. In some ways they are the opposite.
- gumby 6y ago
  Few people seem to understand this
cryptica 6y ago
I think it's still relevant that they show it because it illustrates the irrationality of the situation we're in. I don't see how the notional value can fully cancel out unless it's possible to sell multiple contracts on the same underlying asset. If you want to sell your house, you can't just sell it to two different people at the same time using different contracts. Also, you can't sell your house to someone and also simultaneously rent it out to someone else either... Ultimately there can only be one legitimate contract over any given asset at any given time. It seems that the financial system has legitimized scams by allowing people to sell rights to assets which they do not actually own under the pretext that they will make the transactions necessary to honor the contract 'if necessary'... But it has been proven time and time again that sometimes they cannot honor the contract due to systemic risks... So the contract is bs; people should not be allowed to sell contracts when they cannot provide 100% guarantee that they will be able to honor it... The looming collapse of the financial system is not an excuse to not honor a contract! People should not rely on taxpayer funded bailouts to protect themselves from systemic risks. It makes complete sense to show the notional value because it shows the extent of the deception. It's not hard to imagine how a tiny change in consumer habits could create huge asset squeezes and liquidity shortages. The value is just not there.
- CryptoPunk 6y ago
  In principle, the value of derivatives can represent nothing more than the value that people collectively place on options backed by the collateral of the options and the credit of the option guarantors. This valuation, in the event that it is not a massive miscalculation by the market, reflects the sophistication of the market in being able to incentivize cooperative behavior like contract fulfillment, through phenonema like reputation, and mechanisms like reputation feedback. Financial credibility extending to more sophisticated contracts is a genuine expansion of economic resources, that enables more effective economic coordination. It is not a scam, and the assets that emerge from it are not 'fake' wealth.
  - carapace 6y ago
    But doesn't that line of reasoning fall apart in the face of things like the LIBOR scandal?
jfengel 6y ago
They do mark the vast majority of it as "notional". As you say, that notional value is immaterial: it doesn't actually correspond to anything of value, more akin to you and I writing each other quadrillion-dollar IOUs. It does, however, give a kind of hint at why derivatives have such an outsized effect on the economy. People treat that fake money as if a tiny amount of it were real -- like getting a bank to loan you ten grand backed by my quadrillion-dollar IOU. It can easily become a tail that wags a dog, especially since it's so volatile -- it can evaporate in an instant. It's almost Heisenbergian -- the net value is indeed zero, but somehow it manages to make a tiny difference anyway. It's only important because it's so vast.

by chvid 6y ago

Completely silly to put in the notional value of the derivatives market in there as most derivatives are designed and issued in a way such as the real value is none or cancelled out.

ggrrhh_ta 6y ago

Can you elaborate on that? (Genuinely curious)

quickthrowman 6y ago
For stock options, a vertical spread is a combination of buying and selling a put or a call. I could buy an AMZN call expiring next Friday with a notional value of $300,000 (100 shares at 3000 strike) for $6,250. I could simultaneously sell an AMZN call with a notional value of $300,500 (100 shares at $3005) for $5,855. My net debit would be $395 with a max profit of $105 if AMZN closes above $3005 a share at expiration. In the above I bought a call from someone with a notional value of $300,000 and someone else bought a call from me with a $300,500 notional value. I paid $395 for this setup that has a notional value of $600,500, but the most I could ever get back is $500, the spread between the strike prices.
- ggrrhh_ta 6y ago
  Many thanks, I think I can now understand the initial comment; in the derivatives market, the underlying value is decoupled from the actual money value of the transaction, and the latter is negligible with respect to the notional value.
seanhunter 6y ago
Some examples: 1. Futures are contracts agreeing to buy or sell some underlying asset at a future date (or exchange cash as though you did). If I am long a future someone is by definition short that future. Therefore the total net exposure is always zero. It makes no sense to add my long future to your short future and decide that the total exposure is 2. 2. Swaps are contracts where we agree to exchange cashflows based on some reference amount. The most common types of swaps are interest rate swaps and an example might be a fixed-for-floating swap where you agree to pay me fixed interest (say 4%) and I agree to pay you floating interest (say 3 mounth USD LIBOR plus 200bps). The notional of a swap is the amount we use for the calculation of this interest payment. It really isn't an amount that's used for anything else - you don't owe me the notional and neither do I owe you that. It's just a multiplier we use when we transfer the net difference between the two rates. It therefore makes no sense whatsoever to add up the notional of swaps contracts. Also since we exchange the net difference the notional can be pretty large and the net cash payments pretty small. 3. Credit default swaps are similar to IR swaps except one of the legs of the swap pays out based on certain "credit events" (typically defaults and/or downgrades) on an underlying "reference obligation" (usually a corporate or sovereign bond, but can be an ABS or probably some other stuff). Since different CDSs are based on different underlying reference obligations, adding up notionals of different CDSs makes as much sense as if I say I have 10 dollars, 2 matchsticks, a ball of fluff, a ferarri and a dog so you say I have 15 things. Well I suppose so but it doesn't really mean anything since the things themselves are very different in nature.

RobertoG 6y ago

It's also problematic to put public debt in the same bucket that private debt. Those are very different things. In some ways they are the opposite.

gumby 6y ago
Few people seem to understand this

cryptica 6y ago

I think it's still relevant that they show it because it illustrates the irrationality of the situation we're in. I don't see how the notional value can fully cancel out unless it's possible to sell multiple contracts on the same underlying asset. If you want to sell your house, you can't just sell it to two different people at the same time using different contracts. Also, you can't sell your house to someone and also simultaneously rent it out to someone else either... Ultimately there can only be one legitimate contract over any given asset at any given time. It seems that the financial system has legitimized scams by allowing people to sell rights to assets which they do not actually own under the pretext that they will make the transactions necessary to honor the contract 'if necessary'... But it has been proven time and time again that sometimes they cannot honor the contract due to systemic risks... So the contract is bs; people should not be allowed to sell contracts when they cannot provide 100% guarantee that they will be able to honor it... The looming collapse of the financial system is not an excuse to not honor a contract! People should not rely on taxpayer funded bailouts to protect themselves from systemic risks. It makes complete sense to show the notional value because it shows the extent of the deception. It's not hard to imagine how a tiny change in consumer habits could create huge asset squeezes and liquidity shortages. The value is just not there.

CryptoPunk 6y ago
In principle, the value of derivatives can represent nothing more than the value that people collectively place on options backed by the collateral of the options and the credit of the option guarantors. This valuation, in the event that it is not a massive miscalculation by the market, reflects the sophistication of the market in being able to incentivize cooperative behavior like contract fulfillment, through phenonema like reputation, and mechanisms like reputation feedback. Financial credibility extending to more sophisticated contracts is a genuine expansion of economic resources, that enables more effective economic coordination. It is not a scam, and the assets that emerge from it are not 'fake' wealth.
- carapace 6y ago
  But doesn't that line of reasoning fall apart in the face of things like the LIBOR scandal?

jfengel 6y ago

They do mark the vast majority of it as "notional". As you say, that notional value is immaterial: it doesn't actually correspond to anything of value, more akin to you and I writing each other quadrillion-dollar IOUs. It does, however, give a kind of hint at why derivatives have such an outsized effect on the economy. People treat that fake money as if a tiny amount of it were real -- like getting a bank to loan you ten grand backed by my quadrillion-dollar IOU. It can easily become a tail that wags a dog, especially since it's so volatile -- it can evaporate in an instant. It's almost Heisenbergian -- the net value is indeed zero, but somehow it manages to make a tiny difference anyway. It's only important because it's so vast.