Okay, suppose you're in a room with 11 people. You tell each individual you'll give him a hundred dollars to tell you whether he'll be a buyer below, or seller above, the current price, by the end of the month. Notice, this is not an option, because 1) he isn't locked into any price, and 2) he doesn't have to sell to you specifically!


Understand, the probable sellers - who already know they're probably sellers - are, by definition, people who think the market will go up. And the buyers are people who think the market will go down - or else they'd be buying or hedging (meaning visible) right now, not postponing. These are not natural option sellers, they're natural "gesture" sellers.


So you say to the sellers, if the market is above the current price, and you haven't sold by the end of the month like you said, then you owe me a hundred dollars (credit for early cancellation). If the market is above the current price - which you expect - and you do sell, I owe you a hundred dollars, no matter what the price. If the market is below the current price, neither of us can prove the other was lying, you don't have to sell, I don't have to pay, it's a push.


Notice, every one of the 11 people now expects to buy or sell exactly where he expected to buy or sell anyway, plus make an extra free hundred dollars from you. But what happens, in reality, is that 10 people will reveal they're sellers, and only one will reveal he's a buyer. You pick off the single buyer, pay him his $100 bucks, mark the price down about 80%, and tell the ten unmatched sellers, hey, come and get it.


The trick is, once you know they have a need to sell, there really isn't any need to actually lock in an option from them. They are going to be stuck selling, based on their own need, whether they get assigned or not! As I always say, options and derivatives don't create counterparties, information creates counterparties


eLROY


P.S. So far as legislation,


1) tell me why, again, "scores" aren't useful,

2) is there some law that says borrowers are required to sell mortgages with early-repayment/call options - and get charged extra for "toxic waste" cleanup - and

3) is half of credit derivatives just ways of re-packaging and backstopping "junk" so that more people can own the coupons?