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> I still don't understand why these kinds of derivatives are not banned. They're, as you described, basically betting. Imagine I run a chain of hotels in bea

by Lazare 6y ago

> I still don't understand why these kinds of derivatives are not banned. They're, as you described, basically betting. Imagine I run a chain of hotels in beach resorts. When tourism is up, I make a ton of money; when tourism is down, I lose a ton of money. I'd like to flatten this so I can make a steadier, safer stream of money, budget more sensibly, and not be at risk of going under if 2-3 bad years come in a row. What can I do? Well, maybe I look around and notice that a big spike in jet fuel prices drives ticket prices up, and when ticket prices go up people stay home and I lose money, whereas cheap jet fuel means high occupancy rates. So I might hedge by buying put options (and/or selling call options) on jet fuel. When fuel prices go up, I can offset my low revenues with cash from selling my now-valuable put options (or the cash I received earlier from selling now worthless call options). And when fuel prices go down, I can use some portion of my higher revenues to pay for the cost of the worthless puts I purchased (or to settle the now valuable calls I sold). This sort of thing is common and healthy, not just among end users, but even more so among intermediaries working to remove and reduce the amount of risk inherent in the system. Why are they not banned? Why would they be banned? > Except for a handful of folks, everybody loses money on them. That's not really how this works. Or indeed, could work.

swixi 6y ago
This just seems like a complicated way to go about budgeting correctly. Save money when you have excess from increased revenues, and use that to cover yourself when revenues decrease. I don't understand what is gained by bringing puts into the equation, if they are just as cyclical as your revenues. And it seems to me that you'd need a decent understanding of what your budget should be in order to decide how much to spend on puts in the first place. What am I missing?
- harryh 6y ago
  Saving money requires keeping cash (sometimes a lot of it) in the bank that could otherwise be put to productive use. Options contracts allow offloading of risk without keeping this excess cash sitting there doing nothing. It can be much more capital efficient.
  - haberman 6y ago
    Call me crazy but I thought the idea is that banks would use deposits to fund loans and kick some of the profit back to the account holder in the form of reasonable interest rates. That seems capital efficient to me, but it's apparently a quaint relic of the past now that eternal 0% interest rates are the norm. I'm reminded of the scene from It's a Wonderful Life where George Bailey explains to all his account holders why they can't all withdraw their money at once, because it's being put to productive use by their fellow townspeople: https://youtu.be/iPkJH6BT7dM?t=49 https://youtu.be/iPkJH6BT7dM?t=49
    - dleslie 6y ago
      The banks still do this; they leverage deposits to back the loans they provide. However, they have little to no impetus to provide a reasonable interest rate on savings accounts; they'd much rather pay the absolute possible minimum the market (and regulation) will allow, and pocket the rest as profit.
    - spiralx 6y ago
      Banks don't use deposits to make loans though, that's a widespread misconception which is perpetuated by concepts such as 'fractional reserve banking'. In the modern economy bank lending is simply adding a number to someone's account and adding an equal number to the bank's loan sheet. https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-... Simply put a bank with zero deposits could still lend money, the only constraints are risk and regulation.
  - freeone3000 6y ago
    But you're not offloading risk -- you're increasing risk. What if jet fuel rises for some reason other than increased usage? What if usage is increased, but, people simply aren't visiting your region? Simply doing something with the money is not necessarily better than doing nothing with it. None of the above is productive use -- it's simply betting. Jet fuel producers don't care about your commodity-indexed fund call option.
  - 6y ago

by Lazare 6y ago

swixi 6y ago

This just seems like a complicated way to go about budgeting correctly. Save money when you have excess from increased revenues, and use that to cover yourself when revenues decrease. I don't understand what is gained by bringing puts into the equation, if they are just as cyclical as your revenues. And it seems to me that you'd need a decent understanding of what your budget should be in order to decide how much to spend on puts in the first place. What am I missing?

harryh 6y ago
Saving money requires keeping cash (sometimes a lot of it) in the bank that could otherwise be put to productive use. Options contracts allow offloading of risk without keeping this excess cash sitting there doing nothing. It can be much more capital efficient.
- haberman 6y ago
  Call me crazy but I thought the idea is that banks would use deposits to fund loans and kick some of the profit back to the account holder in the form of reasonable interest rates. That seems capital efficient to me, but it's apparently a quaint relic of the past now that eternal 0% interest rates are the norm. I'm reminded of the scene from It's a Wonderful Life where George Bailey explains to all his account holders why they can't all withdraw their money at once, because it's being put to productive use by their fellow townspeople: https://youtu.be/iPkJH6BT7dM?t=49 https://youtu.be/iPkJH6BT7dM?t=49
  - dleslie 6y ago
    The banks still do this; they leverage deposits to back the loans they provide. However, they have little to no impetus to provide a reasonable interest rate on savings accounts; they'd much rather pay the absolute possible minimum the market (and regulation) will allow, and pocket the rest as profit.
  - spiralx 6y ago
    Banks don't use deposits to make loans though, that's a widespread misconception which is perpetuated by concepts such as 'fractional reserve banking'. In the modern economy bank lending is simply adding a number to someone's account and adding an equal number to the bank's loan sheet. https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-... Simply put a bank with zero deposits could still lend money, the only constraints are risk and regulation.
- freeone3000 6y ago
  But you're not offloading risk -- you're increasing risk. What if jet fuel rises for some reason other than increased usage? What if usage is increased, but, people simply aren't visiting your region? Simply doing something with the money is not necessarily better than doing nothing with it. None of the above is productive use -- it's simply betting. Jet fuel producers don't care about your commodity-indexed fund call option.
- 6y ago