Observations and Insight

Focused: What The Industry Knows About Transparency (Part 2)

Back in November, the industry gathered for the annual FIA Expo event in Chicago. There, John Lothian News used an exhibitor booth (Thanks Cinnober!) as its studio to ask industry participants key questions about transparency issues in today’s markets.

Part 2: What solution would you suggest in order to improve transparency in the markets today?
Watch the video »

Lead Story

OCC Announces John Grace as New Chief Risk Officer
Press Release – OCC
OCC announced today that John Grace has joined OCC as Executive Vice President and Chief Risk Officer. He will be responsible for driving and implementing OCC’s risk management strategy. This includes advising senior management and the Board of Directors on risk issues, overseeing OCC’s Model Validation and Enterprise Risk Management departments and working with regulators from the Securities and Exchange Commission, the Board of Governors of the Federal Reserve System, and the Commodity Futures Trading Commission.

The Higher Moments of Options Trading
 Larry Shover – Fox Business
The “Crash of 1987” and its aftermath provided me with a sharp flash of awareness; one that I’ve never forgotten and one that I share with every trader who’s lived through something similar.  In the derivatives business, we are surrounded by mathematical constructs, risk-metrics and financial theory solely predicated on the bell curve – or, normal distribution. Yet, once you live through a derivatives disaster, you know, deep inside, that derivatives behave in a very non-normal way.
***DA: Those options payoff graphs we learned about in Chapter 1, that showed open ended risk the further the price of the underlying moved? Once in a blue moon we are reminded what open-ended really means.

Shanghai’s option market launch shadowed by regulatory probes, brokerage suspensions
Daniel Ren and  Kwong Man-ki – South China Morning Post
A flurry of reform efforts to make the mainland’s capital markets fit for global investors has sent uncertainty sweeping across the equity arena as brokers face probes into trading irregularities and exchanges struggle to get to grips with a fast-evolving marketplace.

India VIX Rises After Foreigners Buy Index Options for 22 Days
Santanu Chakraborty – Bloomberg
India’s benchmark gauge of protection against stock market swings climbed for a second day amid the longest stretch of index option purchases by foreigners in seven years.
The India VIX Index rose 2.2 percent to a one-week high of 17.65 at the close in Mumbai. Foreigners bought a net $84.9 million of CNX Nifty Index options on Jan. 16, capping a 22nd day of purchases, the longest streak since the period ended Aug. 7, 2007, data compiled by Bloomberg show. The put-call ratio increased to 1.32 as of 4:09 p.m., the most since Oct. 30.
***DA: People are scared of the downside, and it is starting to show.

CME Group Releases White Paper: “Clearing – Balancing CCP and Member Contributions with Exposures”
Press Release – CME Group
CME Group, the world’s leading and most diverse derivatives marketplace, today published a white paper detailing the company’s position on a variety of issues facing central counterparty clearing houses (CCPs) in today’s financial markets, particularly the question of how much “skin in the game” clearing houses should contribute to a market’s financial safeguards.
***DA: The larger question is who gets skinned if a clearing house goes under?

The Option Queen Newsletter
The Swiss National Bank, on Thursday, allowed the Swiss franc to freely float in the market. It will no longer be pegged to the euro at 1.20. Remember, this peg was put into place because the Swiss franc rallied so much that their ability to export was almost wiped out. Thus to help industry, the Swiss National Bank (SNB) decided to peg their franc to the euro which, did achieve their goal. This was a much more clever decision that trying to intervene in the currency market to hold the value of the Swiss franc down, which, in the long run never works anyway.
***DA: Those crazy Swiss. They still care about such things as currency stability and sound money practices. Oh, yeah. And good chocolate.

Commodities, Currency Commotion Brings Volatility
JJ Kinahan – Forbes
Traders return from a long holiday weekend already riding a slippery slope of volatility greased by international events and uncertainty heading into the depths of earnings season.
In fact, volatility is higher across many asset classes. For starters, the CBOE Volatility Index (VIX), which tracks the implied volatility priced into S&P 500 Index (SPX) options, hit a three-week high of 23.43 Friday as the SPX was at risk of a six-day losing skid. But true to Freaky Friday form, the broader market rebounded late in the day.

The Mystery of Short-Term Volatility (VXST)The Options Insider
The Options Insider
Short-duration contracts are all-the-rage in the options market these days. Glance at the ADV on any given options exchange and you’ll find a substantial portion of weekly options lurking in the mix. Even old-school institutional products like SPX have embraced the short-duration craze. SPX Weeklys accounted for approximately 32% of overall SPX contract volume in 2014, up from approximately 23% the previous year.
***DA: No mystery here. Risk exposures are the most dynamic in the short term, hence more reason to turn it over more often.

Why We Should Have Seen the FXCM Inc. (FXCM) Mess Coming
Adam Warner – Schaeffer’s Investment Research
Apparently, forex traders can leverage their positions as much as 50:1. Hard to believe that could come back to bite someone, but guess what? Trading is a risky business. I love the phrase “unprecedented volatility.” Do brokerage/clearing firms only hold capital up to “precedented” moves? Because if that’s all that’s required, it’s pretty much a time bomb waiting to go off. We’ve seen “tail,” or “multi-sigma,” or “whatever you want to call it” in pretty much every asset class over the course of time. And if we haven’t seen it in an asset class, rest assured, we’ll see it someday.
***JB:  We were talking about this in the office this morning.  However, the stat we read was leverage of up to 200:1.

A History Lesson in Volatility and the VIX
Happy Martin Luther King Jr. Day! It’s an important time to remember one of our nation’s great American heros, what he advocated for, and his accomplishments.
In an unrelated note, this three day weekend is a painful reminder in the investment space… after a huge volatility spike… which was what some say was the beginnings of what later became the financial crisis if 2008-2009 {Past performance is not necessarily indicative of future results}. Last year, we covered this five year anniversary, and we feel it’s important to revisit each year. Here’s “A Different Kind of History Lesson (The VIX).”

50,000 Wall Street jobs cut
John Aidan Byrne – New York Post
There’s blood on the Street.
In a wild swing of the ax that has shocked many pundits, Wall Street’s biggest banks have slashed nearly 50,000 jobs, and bonuses and expense money are being cut as profit opportunities dry up.
***DA: The Manhattan Ferrari dealer is starting to worry.


OCC Announces Innovative New $1 Billion Committed Repurchase Facility
Press Release – OCC
Today OCC announced the establishment of an innovative pre-funded, $1 billion committed repurchase facility with a leading pension fund. This new facility increases OCC’s overall liquidity resources from $2 to $3 billion, while diversifying OCC’s committed lenders to include qualified pension funds in addition to OCC’s existing participant base of banks and broker-dealers. Committed liquidity facilities are a critical resource to central counterparties like OCC, ensuring that sufficient capacity is maintained to fund payment obligations to clearing members in a timely way, and thereby promoting the uninterrupted flow of financial markets.

CME Group Announces Increased Offer for GFI Group Stockholders to Receive $5.85 per GFI Group Share
Press Release – CME Group
CME Group Inc., the world’s leading and most diverse derivatives marketplace, today announced it has delivered executed revised agreements to the Special Committee (the “Special Committee”) of the Board of Directors of GFI Group that, if approved, would increase the consideration payable to GFI Group stockholders to $5.85 per share from $5.60 per share, payable in a mix of shares of CME Group Class A common stock and cash.  This new offer price represents more than an 88% premium above the closing price of $3.11 per share of GFI Group common stock on July 29, 2014, the last day of trading prior to the announcement of the CME transaction.
***DA: Turning into quite the bidding war. The ink is not even dry on CME Group’s latest offer and BGC has already upped theirs to $6.10.

CME Group, BGC Again Raise Bids for Broker-Dealer GFI
The bidding war between CME Group Inc. and BGC Partners Inc. for fellow broker-dealer GFI Group Inc. escalated Monday, as both parties raised their bids to win over shareholders ahead of this month’s vote.
***DA: CME Group could end this thing right now if it would just buy BGC instead.

China May Allow Bond Trading Through Hong Kong-Shanghai Link
Eduard Gismatullin and Fion Li – Bloomberg
China may allow international investors to buy bonds and exchange-traded funds through the link between the Hong Kong and Shanghai bourses, according to the Shanghai Stock Exchange.
“We can offer more diversified products,” Huang Hongyuan, the exchange’s president, said through a translator at a presentation in Hong Kong on Jan. 20. “Perhaps we can move to ETFs or bonds; we can perfect further transaction arrangements.”

NYSE Unveils New Trading Room
MoneyBeat – WSJ
New year, new digs for traders at the New York Stock Exchange.
The NYSE, a subsidiary of Intercontinental Exchange Inc., debuted a brand new trading room Tuesday morning before the opening bell. The space, dubbed “The Buttonwood Room,” is next to the main trading floor and houses units for NYSE stock and options market makers and ICE futures participants. It also includes the NYSE Arca customer service desk and NYSE/ICE national operations center.

Regulation and Enforcement

FINRA Proposes Rule Change To Options Reporting
Daniel Dietrich – JDSupra
FINRA Rule 2360 requires that members file reports for each account that has an aggregate position of 200 or more options contracts on the same side of the market covering the same underlying security or index. The reports are commonly called Large Options Position Reports (“LOPRs”).

Futures regulator dogged by questions on conflicts, governance
Lynne Marek – Crain’s Chicago Business
National Futures Association Chairman Chris Hehmeyer thought he finally had good news for an industry beaten up by two massive brokerage failures.
Speaking to the Commodity Futures Trading Commission in April 2013, he said “friends” at a small Chicago-based company called AlphaMetrix had built a software system that would flag potential fraud before it endangered customers. The Chicago-based futures association, an industry regulator, had hired AlphaMetrix for the job, with the blessing of co-regulator and futures exchange operator CME Group.

SEC Pokes Hole in Argument It’s Too Slow to Get Grip on Markets
Sam Mamudi – Bloomberg
Bit by bit, the U.S. Securities and Exchange Commission is answering critics who say it’s asleep at the switch when it comes to high-frequency trading.
The agency announced another record fine Thursday against UBS Group AG (UBSG), saying the bank favored professional market makers when it violated rules designed to ensure stock trades are executed fairly.

Derivatives watchdogs expected to agree swaps rules reprieve
Michelle Price – Reuters
Derivatives watchdogs are expected to agree a new timeline for the introduction of margin requirements for swaps transactions after strong resistance from the international banking industry, Europe’s top securities regulator said.
Speaking on the sidelines of the Asia Financial Forum in Hong Kong on Monday, Steven Maijoor, chair of the European Securities and Markets Authority, told Reuters the European regulator hopes to agree a new timeline for introducing margin requirements for privately-traded derivatives in the coming weeks.

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