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Old 02-20-2002, 06:34 AM
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Default a different kind of phone call?



So far as I can tell from this derivatives discussion, the flip side of every failed sale is a leaning or trading opportunity. And it seems like a swap is just a series of futures, with the difference between where those contracts are trading and where the client gets them paid up front.


So if you locate a natural buyer of a swap, but he's not interested, you either A) buy the futures yourself, assuming you can lean into him, or B) you offer out short puts to speculators at a price where, if some hedge-fund guy buys them from you blindly, he should stay in business indefinitely.


So, frankly, you'd rather not have somebody hedge, and rather just know he needs to. So suppose somebody has a series of liabilities or contingent liabilities in his business plan. All you really want to do is pay him to tell you about his business plan, and thereby create a free option into his natural demand.


So you call him up, and say hi, my name is eLROY, and it looks like you're going to be selling a thousand dollars worth of euros every six months. I'm not trying to sell you anything, no sir, I'd just like to pay you $10.00 to tell me about it every time you do this.


Yes, I'll pay you $10 just to get started. And I'll pay you another $10 the next time you can prove to me you bought dollars. Or, if you're not going to be buying dollars, just tell me that and I'll pay you $10.00 right away. But then you won't get $10 if you do buy them - and I won't be likley to offer to start up the deal again right away. Or, if you say you're going to buy them and then miss just once, the deal ends, only Ill be happy to start up again for, say, $5.00.


See, every time you buy 1000 dollars, you don't get your $10 until you A) buy dollars the next time you said you will, or B) tell me there isn't going to be a next time. So as long as you're going to continue to be doing it, your best off telling me about it and waiting but, as soon as you know you're going to stop, just tell me that and you'll get your last $10 right away, instead of waiting and never getting it. And then we can restart any time, same deal, just give me some advance warning.


The assumption is that a client will sell you visibility into his balance sheet for cheaper than he'll exchange a risk which he is comfortable with, for one he is uncomfortable with. Then, given that visibility, you can take a risk you are comfortable with, at the same time as, effectively, auditing the progress of his business plan.


In this manner, you can uncover a larger supply of options than you ever could by buying options. And at the same time, you can sell someone, like, a swaption or a binary with a knockout or something, to hedge their costs if they ever decide they want to just buy a swap. And if they don't buy that either, well, you can still sell it!


So, on the one side, you have an oil company who doesn't hedge, or who buys a fence, and so you pay him to tell you about it, sell a fence on the cheap - mark it up and move it out to a hedge fund - and then sell a future and lean into the fund, or something. And on the other side, you're buying fuel-cost visibility from an airline, and then selling it to your analysts to sell to their institutional buy-side clients in exhange for tickets.


Or you sell the airline calls, and move those out to the hedge fund too. Is this an oversimplification? Can you maufacture free straddles just by paying people on opposite sides of a remote transaction to talk to you?


Meaning, if we end up with a situation in the economy where a homebuilders can't afford to pay more than $10 a board foot, and forest products people can't afford to manufacture lumber for less than $20.00, you've sold options for free. At least you didn't pay them full fare, and you never could have anyway. And they would have defaulted anyway.


But if the buyer ends up willing to pay $16, and the seller $14... and the hedge funds play airline... as long as you just sold two options... it seems like you make money on your discount short straddle at 15...


Okay, I'm lost!


The whole point is, some people don't want to move risk around, they are comfortable with it when they shouldn't be, and in this case information needs to change hands to someone who is maybe a little brighter, at least enough to make the right decision, and pass on the risk. You just have to give these idiots some justification to keep the phone lines open while they go down.


The more visibility you can buy, the more options and futures you can manufacture yourself, rather than assuming some idiot in industry will see the light. Instead of moving their risk around, you move the management information about their assets and liabilitites - and therefore their profits - around. Leave them with their stupid risk - they want it - and just pay them for something they're comfortable with - talking


eLROY
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