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I am not sure you understand how hedging works. You don't go short and long on the same stock to hedge. You generally take one position (long or short) on the s
by jayp 18y ago
I am not sure you understand how hedging works. You don't go short and long on the same stock to hedge. You generally take one position (long or short) on the stock you are speculating on, and you take the opposite position with stocks in its peer group to protect against swings in the industry. The basis of the hedge is that stock performance is correlated within sub-industry. With a short squeeze like the one of VW stock, this type of a hedge wouldn't have helped.
But that was not my main point for this reply.
The German regulators should care about financial transparency, because even hedge funds (and even naked speculators) provide an counter force to the natural tendency of the stock market to always go up. if shorting was not allowed, the market has a natural tendency to go upwards. everyone benefits from the market always going up -- the buyer, the seller, the company, etc. a buyer can always sell the stock for more later. no one would benefit from a price drop. however, the stock price growth may not have anything to do with reality of company's books. shorting stocks helps keep the stock at a reasonable price point because when the stock price rises unreasonably, plenty of people would like to gain from its pending downward spiral.
as an example, look at china. no shorting is allowed there. their stock market went up, up, up. the balance shorting provided was not not presence. when people realized how vastly over rated the stock market was, it got hit. hit hard. now, it is one of the hardest hit market out there.
shorting (and other financial maneuvers) only work with greater transparency of information.
note that the hedge funds did take a big gamble and paid the price. I do not feel sorry for them.
(Anyway, I am sure I didn't do a thorough job of explaining the benefits of shorting and transparency.)
- nradov 18y agoNo, I understand exactly how it works. If you take a short position by borrowing a stock there is always a small but non-zero risk of completely blowing up due to something like this. It's playing financial Russian roulette. Making the market more transparent reduces the risk a little more, but it's still non-zero. Any trader with common sense would have hedged the downside risk using other derivatives. For example, he could have purchased enough deep out-of-the-money call options to cover all the shares he borrowed. No one is suggesting that shorting or speculation ought to be banned. However I remain unconvinced that requiring Porsche to immediately disclose their VW ownership stake in this case would have had any benefit for the German economy as a whole.
- op12 18y agoNot every trader could have just hedged out the risk of a blowup. that is becuase derivatives are a zero sum game. For every trader who purchased the out of the money call, someone sold it. Therefore that person is now responsible for unlimited downside.
- nradov 18y agoExactly. And if you can't hedge at a reasonable price then you shouldn't make the trade in the first place. Also, if the call seller is covered then he only has a small downside.
- op12 18y agoExactly. But let's take it a step further. Once the call seller covers himself (by buying stock in proportion to the delta of the option), he is essentially causing someone else to be short it as well. The unlimited downside is now passed to him. You can see how this just continues to propagate. The point is that in any situation where shorting occurs, and therefore an excess amount of stock is floating, there is a non hedgeable unlimited downside risk that SOMEONE has to bear. Whether you pass it off in option or stock form is not relevant. Not everyone can hedge unlimited downside. Proper rules try to make sure these artificial squeezes do not happen, so as not to discourage short sellers (who are extremely, extremely important). Now, that isn't to say that VW should be forced to reveal their position. It is not a trivial question what is the optimal way to stop this kind of thing. But it's important to discourage this activity where people deliberately accumulate shares to squeeze shorts. No economic value is created in this type of activity, just a transfer of wealth, whereas shorting serves a very important economic function.
- nradov 18y agoThat's not usually how it works. Most covered calls are sold by investors who already own the stock and want to juice it for some extra return. They're not going out and buying more, so the unlimited downside simply doesn't exist. I still fail to see the problem with discouraging short sellers from making stupid unhedged speculative bets.
- jlujan 18y agoTransparency is all well and good. I am sure that is happily accepted oversight/regulation. So I wouldn't expect any arguments that hedge funds need way more oversight/regulation. On the issue of transparency, why not require hedge funds to disclose their short positions? This is all such a farce. To hell with them. How can you ignore the possibility that having a derivatives market that is ten (10) times the size of the global GDP, might be an issue?