Nifty trend
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Deepak Shenoy on the world of money
BY DEEPAK SHENOY
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The Illusion of Low-Risk
November 24, 2010
"A person often meets his destiny on the road he took to avoid it." - Jean de La Fontaine
Funnily, the above quote came to me through a recorded movie; I am not really fond of French poetry. But it triggered a thought - that this seems to be what we're doing in the whole financial world recently, and as an addition, it seems like we expect to die before we meet our destiny.
Take Aditya Birla Money. According to Forbes, ABM sold investors a "risky options strategy" called Options Maxima as a safe investment; and later, when the market took a steep upturn, lost 103 crore rupees! The problem? The feeling of high returns for low risk. In the last year prior to September, the market had stayed in a fairly narrow trading range, so it had been very profitable to write "option strangles" - positions that would make money if the market stayed in that range but lose an unlimited amount if it went beyond. From October 2009, I have heard of brokers and high net worth individuals doing this as a planned strategy - writing strangles such that they made some money if the Nifty stayed within a range as wide as 4000 on the lower side, to 6000 on the upper side. With the Nifty firmly ensconced in the 4800 to 5300 trading range, they made money for a number of months, and the strategy seemed like shooting ducks in a barrel.
Since then, multiple PMS products have come forth with such a strategy, and as it happens when everyone piles on, the yield on the trade dropped drastically. The response? Use a narrower range, and leverage up to get higher returns. Eventually in September, the Nifty shot up way beyond and crossed 6000, making these option strangles lose enormous money - especially because they were highly leveraged. If they were less leveraged, they wouldn't make the return they wanted - upwards of 2% a month - and which the brokers nearly guaranteed because, look, this strategy hasn't lost money for a year.
It doesn't really take a black swan event to unravel things like this. A black swan is an event that you couldn't foresee from the known past, reflecting the belief that swans were synonymous with the colour white until the day a black variety was seen. This Nifty move of about 11% in a month isn't a black swan - just in May 2009, the election furore took the Nifty from 3600 to 4200 in one day - a move that triggered the market circuit breakers on the upside. Ignore that? Well, in October 2008, just two years ago, there was a 10% down move in a single day. And again in Jan 2008. And once more in October 2007. If large moves have happened overnight four times in two years, and you have a strategy that loses big amounts of money on such large moves, it is foolish to call it "safe".
*************
Deepak Shenoy on the world of money
BY DEEPAK SHENOY
The Illusion of Low-Risk
November 24, 2010
"A person often meets his destiny on the road he took to avoid it." - Jean de La Fontaine
Funnily, the above quote came to me through a recorded movie; I am not really fond of French poetry. But it triggered a thought - that this seems to be what we're doing in the whole financial world recently, and as an addition, it seems like we expect to die before we meet our destiny.
Take Aditya Birla Money. According to Forbes, ABM sold investors a "risky options strategy" called Options Maxima as a safe investment; and later, when the market took a steep upturn, lost 103 crore rupees! The problem? The feeling of high returns for low risk. In the last year prior to September, the market had stayed in a fairly narrow trading range, so it had been very profitable to write "option strangles" - positions that would make money if the market stayed in that range but lose an unlimited amount if it went beyond. From October 2009, I have heard of brokers and high net worth individuals doing this as a planned strategy - writing strangles such that they made some money if the Nifty stayed within a range as wide as 4000 on the lower side, to 6000 on the upper side. With the Nifty firmly ensconced in the 4800 to 5300 trading range, they made money for a number of months, and the strategy seemed like shooting ducks in a barrel.
Since then, multiple PMS products have come forth with such a strategy, and as it happens when everyone piles on, the yield on the trade dropped drastically. The response? Use a narrower range, and leverage up to get higher returns. Eventually in September, the Nifty shot up way beyond and crossed 6000, making these option strangles lose enormous money - especially because they were highly leveraged. If they were less leveraged, they wouldn't make the return they wanted - upwards of 2% a month - and which the brokers nearly guaranteed because, look, this strategy hasn't lost money for a year.
It doesn't really take a black swan event to unravel things like this. A black swan is an event that you couldn't foresee from the known past, reflecting the belief that swans were synonymous with the colour white until the day a black variety was seen. This Nifty move of about 11% in a month isn't a black swan - just in May 2009, the election furore took the Nifty from 3600 to 4200 in one day - a move that triggered the market circuit breakers on the upside. Ignore that? Well, in October 2008, just two years ago, there was a 10% down move in a single day. And again in Jan 2008. And once more in October 2007. If large moves have happened overnight four times in two years, and you have a strategy that loses big amounts of money on such large moves, it is foolish to call it "safe".
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