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The way these deals work is simple: 1) For some reason, they have an outsized position that they want to reduce. Circumstances include: - Proprietary trading

by niggler 14y ago

The way these deals work is simple: 1) For some reason, they have an outsized position that they want to reduce. Circumstances include: - Proprietary trading group wants to liquidate a position without having to go to the open market - Firm obtains a large position as part of a block deal. In this case, I suspect they engaged in a deal with a hedge fund that had a large exposure to AAPL and wanted to get out. GS would have acquired the position at a significant discount (say, 5% below market price). 2) They need to find clients to soak up the exposure. To do this, they construct investment products that allow them to offset the exposure without having to directly move the inventory. Offering shares directly would have to be essentially free, but products can be sold with some extra fees. To summarize, they have a long position in AAPL and taking the opposite side of a derivatives trade helps balance the net position. Note that if the clients made money then you wouldn't hear about the deals. It's only because clients lost that we are hearing about this.

yummyfajitas 14y ago
Indeed - market making deals like this are how GS makes money. On an individual deal, GS may make or lose money. But in aggregate, GS is only after the aforementioned 5% - the goal here is to sell liquidity for 5% and close the position as fast as possible. Further, the fact that a GS analyst said something is irrelevant. The analyst is an independent adviser to GS's brokerage clients, and is not informed what the prop trading dept is doing. In fact, it would be illegal for the prop traders to tell Bill Shoppe what they are doing, or for him to give them advance notice of his analysis.
thingylab 14y ago
No. If you have a block of shares, there are much better ways to get rid of them. These deals typically take a long time to structure, market and initiate. Besides, you really don't need a lot of shares to hedge this type of product. You need options that are typically (at least initially) deep-ish out of the money and so have little delta.
- fmstephe 14y ago
  Could you please elaborate on this comment? Thanks.
  - niggler 14y ago
    If you had a long position of 100 shares, you could reduce your risk exposure buy selling a call option or buying a put option. (each contract has a notional exposure of 100 shares) Buying a put option requires an upfront payment but you will receive money if the price falls below a specified price (the "strike price"). On the other hand, you receive money when selling a call option but may have to pay later (or hand over your shares) if the stock price jumps above the strike. The problem is that this mechanism only works because there's a counterparty willing to do the trade. You can see the option premium (cost) for a variety of strikes on most financial sites (e.g. https://www.google.com/finance/option_chain?q=NASDAQ%3AAAPL https://www.google.com/finance/option_chain?q=NASDAQ%3AAAPL) As more people buy put options, the price of the put option goes up. As more people sell calls, the price of the call option goes down. If you have a small position (say, 1000 shares), your trade wont move the options market much, but if you have a large position your trades will affect the market makers (they also have a book and are looking to reduce their exposures profitably as well)
- niggler 14y ago
  We are talking about positions on the scale of the Knight Capital Group or Rochdale Securities error (both concerning positions much larger than 1B USD), for which purchasing options could not solve the problem (the required options would be far more than options market makers would buy at a reasonable price). Remember, just because the MM would buy or write one contract doesnt mean they'll buy or write tens or hundreds of thousands of contracts at the price.
  - thingylab 14y ago
    Please re-read my comment. I'm not saying you need options to get rid of a large block of shares. What I'm saying is that trying to get rid of a lot of shares through $30MM worth of a reconv is very ineficient, if not downright stupid.

by niggler 14y ago

yummyfajitas 14y ago

Indeed - market making deals like this are how GS makes money. On an individual deal, GS may make or lose money. But in aggregate, GS is only after the aforementioned 5% - the goal here is to sell liquidity for 5% and close the position as fast as possible. Further, the fact that a GS analyst said something is irrelevant. The analyst is an independent adviser to GS's brokerage clients, and is not informed what the prop trading dept is doing. In fact, it would be illegal for the prop traders to tell Bill Shoppe what they are doing, or for him to give them advance notice of his analysis.

thingylab 14y ago

No. If you have a block of shares, there are much better ways to get rid of them. These deals typically take a long time to structure, market and initiate. Besides, you really don't need a lot of shares to hedge this type of product. You need options that are typically (at least initially) deep-ish out of the money and so have little delta.

fmstephe 14y ago
Could you please elaborate on this comment? Thanks.
- niggler 14y ago
  If you had a long position of 100 shares, you could reduce your risk exposure buy selling a call option or buying a put option. (each contract has a notional exposure of 100 shares) Buying a put option requires an upfront payment but you will receive money if the price falls below a specified price (the "strike price"). On the other hand, you receive money when selling a call option but may have to pay later (or hand over your shares) if the stock price jumps above the strike. The problem is that this mechanism only works because there's a counterparty willing to do the trade. You can see the option premium (cost) for a variety of strikes on most financial sites (e.g. https://www.google.com/finance/option_chain?q=NASDAQ%3AAAPL https://www.google.com/finance/option_chain?q=NASDAQ%3AAAPL) As more people buy put options, the price of the put option goes up. As more people sell calls, the price of the call option goes down. If you have a small position (say, 1000 shares), your trade wont move the options market much, but if you have a large position your trades will affect the market makers (they also have a book and are looking to reduce their exposures profitably as well)
niggler 14y ago
We are talking about positions on the scale of the Knight Capital Group or Rochdale Securities error (both concerning positions much larger than 1B USD), for which purchasing options could not solve the problem (the required options would be far more than options market makers would buy at a reasonable price). Remember, just because the MM would buy or write one contract doesnt mean they'll buy or write tens or hundreds of thousands of contracts at the price.
- thingylab 14y ago
  Please re-read my comment. I'm not saying you need options to get rid of a large block of shares. What I'm saying is that trying to get rid of a lot of shares through $30MM worth of a reconv is very ineficient, if not downright stupid.