Quote from mind:
i am very suspicious to this kind of trade. usually there
is an effect that fools the human eye. in this case for
example it looks like an obvious trade for buffet. but if
you take the current situation into account, how MTM
is bringing him into trouble, things start to look different.
what i am trying to say is that these products do not
only have a situation on expiration date. the cost of
holding capital against the daily VaR need to be take
into account as well - which they often aren't.
either you have a complete fool on the other side who is
willing to overpay an option, or it is you who is the fool.
and if you don't know the answer for sure: it's certainly
you. there is no free lunch. i for myself would never
ever do such trade.
my thinking is like that: in this size, you don't have
fools at counterparties (admittedly a conservative
assumption). and whatever price for the option comes
up, it is derived out of current market prices. directly.
it is the outcome of all products currently traded. but
it is seemingly so in your favor. and this is what i am
suspicious about. when the VIX makes a spike we
know that later months are reluctant to follow. when
the short end in rates fluctuates widely, we know that
the long end doesn't. whereever we have something
traded with high liquidity with some time perspective
build in, we know that this later point takes into account
all the in-between-action very efficiently. and my point
is that it is the same with this kind of option: what is
so seemingly in your favor is an illusion. or at least
partly. it is just a trade like everything else BUT it has
certain disadvantages, like MTM risks, counterparty
risks and so forth ...
finally. over the span of a decade our imagination of
what can truly happen is at risk of failing dramatically.
the world CAN differ significantly from now. just look
at the last eleven years. we had the LTCM, net bubble,
911 and now the assumed great recession. don't add
illiquidity of your instruments on top of that. and in
such products illiquidity constantly surrounds you.
some swap here and there, some fx hedge (maybe
the four indices where not US only) and so forth. all
of a sudden you have counterparty risk with various
financial institution. they won't fail all at the same
time your model makes you believe ... well ... this kind
of thinking is at the very heart of the current crisis.
