Mr. Hedge Unleashed

Market-stabilizing regulations, which protected companies’ stock from an inevitable international “leveraged” feeding frenzy were jettisoned. A hedge fund can now buy unlimited “insurance” on shares of any stock (for pennies on the dollar) and control its price through the buying and selling of the insurance (derivative put options) without ever investing in the company.
Buying covered “put” stock options is like paying an insurance premium to cover an unexpected decline in ones stock’s price and is a conservative and healthy risk management practice when effectively regulated.

If Mr. Hedge owned 1 million shares of XX stock @ an average of $40.00 a share (forty million dollars), he could “hedge” his bets under the former regulations by paying a “put-premium” for a kind of insurance protecting him against a decline in the price of XX. A large holding company would sell the stock insurance coverage and collect the premium from Mr. Hedge.
This is called “writing” a put option for those investors buying them. The insurers collect the premiums for a “derivative” income stream. (Derived from premium income.)
Like other insurance products, the shorter the period for which Mr. Hedge buys the “insurance” (along with the low statistical probability of extreme loss occurring) the cheaper the insurance premium will be.

A purchase of this insurance on speculation that a quality company like XX falls in price from $40.00 to $20.00 in only 90 days given no other rogue factors would be historically, highly improbable. (in a sane trading environment) Thus, the “premium” would be dirt-cheap.
Coverage against such a rapid decline in XX price might cost as little as $2.00 per contract (protecting 100 shares).

A purchase of 10 thousand contracts would help to insure 1 million shares or, 40 million dollars on XX for a premium of $20,000.00. If there is no decline within 90 days, the insurance contracts expire. This is known as hedging, a facet of “risk management” and is normally a principal conservation practice, used by all financial institutions.

Now, let us de-regulate this otherwise conservative practice so that anything goes.
With essentially no regulation or oversight, Mr. Hedge now sets out on a creative financial journey. He buys 1 million more 90 day put contracts at $2.00. without buying any more XX stock. Total premium outlay: 2 million dollars. These are called “naked or Bear put options because Mr. Hedge has not “covered” his insurance purchase with an actual purchase of the equivalent amount of xx stock. Why?

If the price of XX falls to around $20.00 in the next 30-90 days, he can exercise his 10 thousand contracts of insurance on his XX holdings effectively offsetting his loss. It is absurdly unlikely that natural market forces will so quickly drive XX’s price down to the levels projected. However, he owns so many shares of XX that he may be able to help things along.
“Why would Mr. Hedge want to drive down the price of his own shares?”

The REAL Agenda:
Unregulated and insured to the hilt, Mr. Hedge begins short selling XX (another way of betting against the stock) – while selling off /dumping large amounts his actual XX stock holdings, causing market panic selling-momentum. Amazingly, there are no regulations to stop him. As expected, XX begins falling.

Next, Mr. Hedge begins collecting on his some of his put insurance contracts for his stock losses. He continues unloading shares at a terrific rate. The markets notice his purchase of 1 million naked put contracts and it spreads like wildfire. The price decline continues while other traders, panicking, pile in and sell their shares, buying puts, just like Mr. Hedge.
News and speculation enter the mix. No one knows why prices were falling, not even the bewildered, under-suspect executives at XX. Next, other investors flock to insurers, buying up put options on XX to insure against further losses. Supply and demand cause the premium price on XX put options to skyrocket, and Mr. Hedge just so happens to own…1 million contracts.

Here’s Where The Money Is Made Hand Over Fist!
Now, Mr. Hedge begins “re-selling” on the open market the excessive 1 million put contracts he purchased at $0.02 per share/$2.00 per 100 share contract. They now sell for $4.00 or 400 DOLLARS PER CONTRACT.
Over the next 40-60 days, as XX crashes, Mr. Hedge unloads 1,000,000 XX put contracts in worldwide markets at an average of $400.00 per contract. His profit: 400 MILLION. He is now in A FAR MORE PROFITABLE unregulated insurance-reseller business, and could care less about investing in actual stocks.

Mr. Hedges of Wall Street are now buying and selling the World’s Economy, freely, through the unrestricted leveraging of insurance contracts.
XX Corp was not an ailing company. Finding an ailing company to abuse using such unmitigated tactics is no longer necessary. Any good company will do.
No Questions Asked.
After the collapse, from writing too much of the put insurance, our government now helps Mr. Hedge collect insurance benefits owed him from defunct companies, by using our tax dollars. We are throwing billions through the doors of giant insuring companies (and all those institutions who suddenly thought it wise to start selling unlimited insurance coverage to Wall Street hedge fund companies). It was and is -going straight out the insurers back door, to pay Mr. Hedge his profits. They continue, even today, to operate unregulated.

For the Mr. Hedges to have had their way with America completely, the Uptick rule and Margin Limits and Oversight all had to go. Curiously and quietly they did. Finally, as the markets went into the inevitable tailspin.

star

Related Posts:

• “Inaction could lead to average family premiums rising above $22,000 within a decade.”
• The change and recovery
• Rivals Circle As Capital Constraints Pull AIG Stock Down >AIG
• Don’t UNDERESTIMATE the severity of this recession and the corruption.
• This just blows my mind! The table below is a list of the total derivative holdings of the top 25 holding companies as reported by the OCC (in $TRILLIONS).

Leave a comment