Observations & Insight

Risk Off: How The Industry Can’t Fail
Jim Kharouf – JLN

Bruno Iksil, aka “the London Whale,” has issued a letter to the media arguing that his actions in the market were directed and overseen by senior executives at J.P Morgan Chase when it lost $6 billion in 2012.

What is troubling about the case is that it is still a story. In pre-2008 years, if a trader lost a large sum of money, it was called a losing trade. But these days, it’s cause for a multi-year investigation. The crux of the problem with this case is simply this: J.P. Morgan Chase lost $6 billion, but it HAD and HAS the money to cover the loss. If it didn’t have the cash to cover, then we are talking about something very different indeed.

Of course, in the wake of the 2008 financial crisis, there has been heightened focus on counterparty risk, increased margin and capital requirements, pre-trade risk controls, post-trade analysis and so on. Should the bank fall under scrutiny for failed risk management? Maybe, if such margin and other risk management thresholds were breached. But the case should be done and over with by now. If Iksil did nothing wrong, he should be allowed to move on with his career and life. If J.P. Morgan has learned from the error and implemented better risk management structures, let’s move along.

It would be easy to equate J.P. Morgan’s Whale case with say, AIG or others during the 2008 meltdown, but for this one simple fact — they have the cash to cover the loss.

Of course, we can’t have a heads I win/tails the taxpayers lose situation, either. In 2008, what angered both sides of the aisle is that, after the fact, many of the risk takers did not lose one dollar of their personal fortunes. If the taxpayers are to come to the rescue, it should be after the Bruno Iksils and his superiors have their bonuses clawed back. So the global regulatory overhaul includes capital charges, leverage limits, liquidity coverage and other rules designed to give banks a backstop to prevent a passing of the hat to society at large. The downside of this, of course, is that idle capital is a drag on productivity and growth. Finding that sweet spot continues to be a challenge for our banks.

The danger in today’s environment is that we’re at a point where institutions are not allowed to take risks or lose money. This has a deleterious effect on the markets, as banks shutter trading operations and pull out of various sectors in the trading ecosystem.

Lead Stories

London Stock Exchange Is in Merger Talks With Deutsche Boerse
John Detrixhe – Bloomberg Business
The chief executive officers of both companies are keen dealmakers. LSE Group head Xavier Rolet has bought an index provider and expanded into clearing, while Deutsche Boerse boss Carsten Kengeter spent $1.5 billion in his first 60 days in charge of Europe’s largest derivatives exchange.

****SD: This is the big (deja vu) news of the day and also represents a huge can of worms. How will regulators view a potential clearing behemoth? Will other exchanges jump into the fray? Here are some of the many takes floating around: WSJ’s London Stock Exchange, Deutsche Börse Bet on New World of Mega-Exchanges, Financial News’ Why an LSE-Deutsche Börse tie-up makes sense, FOW’s LSE, D. Boerse merger faces twin threat, Reuters’ LSE, Deutsche Boerse try again to create European champion, the FT’s A history of the LSE’s merger talks (it’s long) and the Telegraph’s London Stock Exchange in merger talks with German rival

SEC Urges DC Circuit To Uphold Clearing Corp.’s Capital Plan
Ed Beeson – Law360
The U.S. Securities and Exchange Commission on Monday urged the D.C. Circuit to deny a request from a group of Wall Street giants that want the court to issue an emergency order blocking the Options Clearing Corp. from enacting a capital plan that they say will unfairly benefit its owners. In a brief responding to a newly filed suit, the SEC said Bats Global Markets Inc. and its two fellow petitioners “do not even come close” to meeting the D.C. Circuit’s standards for imposing an emergency stay on the OCC’s capital plan. The SEC also said the petitioners are incorrect when they say the agency didn’t appropriately vet the OCC’s plan, which calls for raising the clearinghouse’s capital reserves in light of its designation as “systemically important” for the workings of the U.S. options trading sector.

US ETF options cover broad range of funds
Gary Delany – TradingFloor.com
Exchange-traded funds have growing increasingly popular among investors as a way to track an underlying index or sector portfolio easily and at low costs. But investors are generally less familiar with the broad range of opportunities available in options on such funds.

As U.S. crude rallies, investors jump on bearish options bets
Despite a rally on Monday, bears are still in the driver’s seat of the U.S. crude oil market, options data showed, leaving the market vulnerable to another leg down. U.S. crude futures rallied more than 6 percent to $31.48 a barrel on Monday, one of their biggest one-day gains in months, as speculation about falling U.S. shale output and a rally in equities fed the notion that crude prices may be bottoming after a 20-month collapse.

****SD: Also see Hedge funds turn attention to oil storage. From that story: “Hedge funds have taken an increasingly nuanced position on oil prices since the start of the year, becoming more bearish towards U.S. crude but bullish towards Brent.”

VIX Futures Send a Bullish Signal for Stocks
Saumya Vaishampayan – WSJ
A bullish signal for stocks is brewing in the VIX futures market.
The CBOE CBOE Volatility Index is based on the prices of S&P 500 options and gauges expectations for stock swings over the next 30 days. Investors tend to rush to S&P 500 options when they’re fearful of stock declines, giving the index its nickname: the fear gauge.
The index is a calculation, not a trading instrument. Investors seeking to make bets on future volatility can do so by buying or selling futures, options or exchange-traded products tied to the index. An investor who buys a VIX contract is betting that the VIX will rise.


NYSE begins shift to new trading platform
Michael del Castillo – New York Business Journal
The New York Stock Exchange today began trading for the first time with its new technology that will someday lay beneath all of its trades, on every exchange.
While today’s trading of the new platform called Pillar will be relatively sparse — only three stock symbols will be put to work using it — the move is only the most recent of other steps made by the aging stock-exchange to remain nimble.

Japan Exchange pledges derivatives push
Julie Aelbrecht – Futures & Options World
The Japan Exchange Group said it plans a major sales push behind its derivatives products after organisational and management reshuffles at the Asian group. The exchange said in a statement on Monday it plans to set up a new derivatives business development department in the Osaka Securities Exchange, part of JPX, to strengthen the sales and marketing functions for derivatives. The move is timed to coincide with JPX’s plan to roll out its new derivatives trading system, developed by Nasdaq, in July.

Open Interest for Options on MSCI Emerging Markets Index (MXEF) Grows to 6,229 Contracts
Matt Moran – CBOE Options Hub
Open interest for options on the MSCI Emerging Markets Index (MXEF) recently rose above 6,200 contacts for the first time. Over the past month the MXEF options open interest grew from 98 to 6,229 contracts.

****SD: When CBOE execs said at their press luncheon that they were seeing an increasing demand from traders to gain exposure to China, I didn’t expect to see the pudding’s proof this fast.

SPX Wednesday Weeklys Begin Trading on Feb. 23
Matt Moran – CBOE Options Hub
Beginning Tuesday, February 23, CBOE will list for trading weekly options on the S&P 500 Index which expire on Wednesdays (“SPX Wednesday Weeklys”). Like other SPXW options, SPX Wednesday Weeklys are series of the SPX option class.

Regulation & Enforcement

Bats Receives SEC Approval for Client Suspension Rule
Bats has received SEC approval of the Bats Client Suspension Rule, which allows the company to take swifter action to prohibit manipulative behavior, such as spoofing and layering, on the Bats Exchanges.

****SD: After seeing it as “BATS” for so long, “Bats” just doesn’t look right.

EU curbs on food speculation could still leave millions hungry, activists warn
Sam Jones – The Guardian
Proposed EU rules designed to curb speculation on food and other commodities are not strict enough and could still see price spikes that leave millions hungry, a coalition of NGOs has warned. In January 2014, the EU agreed to introduce controls to regulate excessive price speculation by limiting the use of financial instruments linked to commodities – such as sugar, wheat and corn – which has been blamed for food price increases.

****SD: Sounds like someone really drank the “derivatives are financial weapons of mass destruction” Kool-Aid with breakfast.


Nasdaq adds machine learning to surveillance platform
James Rundle – Financial News
Nasdaq has signed a partnership with Digital Reasoning that will allow it to incorporate machine-learning technology into its Smarts platform, a step that will increase trading firms’ abilities to monitor for fraud and market abuse.

Eurex fixes tech glitch, launches probe
Alice Attwood – Futures & Options World
Eurex opened as usual on Tuesday after the European exchange fixed a technical problem that caused it to suspend trading for nearly two hours on Monday morning. A spokesperson told FOW the group is conducting a probe into the cause of the problem, adding that trading was halted “due to messaging problems in the back-end infrastructure”. As reported by FOW, the futures exchange suspended trading on Monday morning after a technical problem hit its main T7 trading system. The firm said at the time it was experiencing “serious issues” with the system in a note to clients. Eurex said on Monday: “In order to avoid any threat to the functioning of exchange trading, on-exchange trading in Eurex has been suspended until further notice.”


Study Analyzes Performance of CBOE S&P 500 (SPX) Options-Selling Indexes
Press Release – CBOE
The Chicago Board Options Exchange (CBOE) today announced the release of a new study that examines six benchmark indexes that write Standard & Poor’s 500 Index (SPX) options, comparing their performances with those of traditional stock, bond and commodity indexes. The options-selling indexes generally had returns that were similar to those of the S&P 500 Index, but with lower volatility and lower maximum drawdowns. The report, “Performance Analysis of CBOE S&P 500 Options-Selling Indices,” is the first comprehensive study that examines the performance of options-strategy benchmark indexes that incorporate iron condor and iron butterfly strategies.

The big bet against market volatility
Stephanie Yang – CNBC
As the volatility index hit its lowest level of the year this week, one trader placed a large bet that stocks will continue to rally.
The CBOE volatility index, also known as the VIX, measures investor uncertainty based on the price of S&P 500 options. Put options can be used as a hedge against downside risk, so the higher the price, the more investors are willing to pay for that protection.
On Monday, one trader bought 13,000 of the VIX June 15-strike put options for 20 cents each. This is a $260,000 bet that the VIX will fall below 15 by June expiration (since VIX options have a $100 multiplier).

****SD: And for a counterpoint, see the story below.

Playing Volatility Via The VIX Has Little Downside Right Now
Fox Business
In a new report, Deutsche Bank analyst Rocky Fishman discusses the limited downside potential the firm sees in the VIX right now. According to Fishman, there are plenty of reasons to believe that the market will remain fearful and volatile in coming weeks.

How to Trade Chinese Stocks for the Liu Bounce
Steven M. Sears – Barron’s
Winston Churchill’s long-ago observation of Russia seems increasingly apt for China: it is a riddle wrapped in a mystery inside an enigma.
So much is unknown, and impossible to verify about China, that keying trades off government news remains a reasonable (not foolproof) approach for anyone interested in using China’s opaque markets to wager on the nation’s economic potential.
China’s government recent replaced the leader of the China Securities Regulatory Commission, Xiao Gang, for allowing a speculative bubble – some might say crash – to occur last summer.

Bullish Gold Options Are Priciest Since 2011
Chris Dieterich – Barron’s
Gold has been popular choice for investors looking to hedge their bets in market turmoil.
The precious metal tumbled 1.8% to $1,210 an ounce on Monday, but is clinging tightly to a 14% advance so far in 2016. Gold’s price increase is showing up in the options market, where traders have flooded the zone with bullish bets on additional gains.

The Iceman Selleth
Meredith Kelley Zidek – CBOE Options Hub
Sometimes it’s worth letting something simmer on the stove a while to get impressive results, or in this case it’s more like letting something ferment in earthenware pots buried in a forgotten location. But the feast five months later is worth the wait and the worry!

****SD: If only Val Kilmer was a trader…


The Completely Absurd (and Infuriating) Reason CEOs Get Paid So Much
Ian Salisbury – Time
Options are confusing.
For years economists—not to mention everyday Americans hanging out on bar stools or on Twitter—have argued about why even mediocre CEOs get paid such ridiculous sums of money.
Of course, corporate bigwigs have always been handsomely rewarded. But in the past generation, average pay for CEOs at American’s largest companies has leaped nearly sixfold, from $2.8 million a year in 1989 to $16.3 million today, according the Economic Policy Institute. Exactly why this has happened is a matter of some debate, even among experts. Arguments range from corporate self-dealing to the just rewards for talent in a free-market system.
Now researchers from Dartmouth and the University of Chicago have examined years of pay data to offer up a new explanation: Boards have been handing CEOs bigger and bigger slugs of company stock because they don’t understand how stock options—a key component of CEO pay—work.

****SD: That first sentence = the reason for every previous, current and future educational effort rolled up into three words.


Why I Go to CBOE’s Risk Management Conference
Mark Sebastian – CBOE Options Hub
Next week is the CBOE Risk Management Conference, of all the events that are put on by different exchanges, associations and nonprofits, this is the only one that I absolutely refuse to miss. Considering how great many great events there are, that is saying something but it is true for a multitude of reasons.

****SD: Free gear?

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