JP Morgan

[AAABBBCCC]

Originally Posted by Jack

The point is they're a bank and shouldn't be doing this shit in the first place. If they want to do this stuff they should give up being a bank.

Should a big bank that makes loans to businesses and consumers be involved in capital markets or trading? Are there any advantages of having both operations at the same time?

[whisper]

Originally Posted by AAABBBCCC

Should a big bank that makes loans to businesses and consumers be involved in capital markets or trading? Are there any advantages of having both operations at the same time?

There are some advantages - the bank has less frictional costs being in the capital markets because they already have staff in the capital markets on behalf of their clients.

Banks get int trouble when they think their presence in the capital markets on behalf of their clients actually confer insight to the capital markets. Which usually ends up in the banks eventually being hit with a big loss....

[Alexisonfyre]

Originally Posted by whisper

Not necessarily.

JP Morgan _took_ a position. They lost money because they took _the wrong_ position. Had their position been correct, we may be writing about another company who was on the wrong end of that transaction.

You can't take a position in the market without risking a loss.

I feel like my post wasn't clear enough. Here's what I am trying to understand :

From what I've read, JP Morgan took a huge position in a short term protection index for his high-grade investments and sold a huge position index in a long term protection for the same investment. From what I understand, these positions represented over 30% of these indexes.

Now what happens when you buy a lot of stock is that each additional unit is more expensive than the last. Buying and selling that much in a market that isn't all that liquid means that the price they were paying for short-term protecion was extremely high and money they were receiving for long-term protection extremely low. Arbitrageurs saw that and took positions to recalibrate the market, resulting in losses for JP Morgan.

[whisper]

Originally Posted by Alexisonfyre

Here's what I am trying to understand :

From what I've read, JP Morgan took a huge position in a short term protection index for his high-grade investments and sold a huge position index in a long term protection for the same investment. From what I understand, these positions represented over 30% of these indexes.

The size of the position is only relevant in the scale of the potential size of the loss/gain.

They believed that market would move in such a way that the short term position (what they bought) would pay off more than the long term position (which they sold).

They took a position on how the market would move.

The market moved differently than what they thought it would. That is why they lost money.

[Westley]

Originally Posted by Alexisonfyre

From what I understand, these positions represented over 30% of these indexes.

Curious what this means - I haven't followed this all that closely, but this sentence seems to be hard to take at face value.

If you look at DIA, the index that tracks the Dow Jones Industrial Average, there's a total of $11B in that ETF. I could believe that they made a bet that constituted $4B; but that does NOT represent "over 30%" of that index - it represents a tiny fraction of the index, which certainly has its market cap measured in the trillions, because the Dow Jones Index covers the largest of companies.

So, unless they actually held 30% of the index, which is possible but seems very difficult for me to believe, it doesn't make sense to believe that there was a significant movement for the arbitrageurs to take advantage of.

Originally Posted by Alexisonfyre

Now what happens when you buy a lot of stock is that each additional unit is more expensive than the last. Buying and selling that much in a market that isn't all that liquid means that the price they were paying for short-term protecion was extremely high and money they were receiving for long-term protection extremely low. Arbitrageurs saw that and took positions to recalibrate the market, resulting in losses for JP Morgan.

[Alexisonfyre]

@whisper and Westley: I fully understand your points.

If you have some time, read the articles in the following series :

http://ftalphaville.ft.com/blog/seri...watching-tour/

Let me know what you think about it.

[whisper]

Thumbing through it, it seems to be speculating on what JPM did and is doing to exit their position.

[Eimon Gnome]

Originally Posted by whisper

The size of the position is only relevant in the scale of the potential size of the loss/gain.
They believed that market would move in such a way that the short term position (what they bought) would pay off more than the long term position (which they sold).

They took a position on how the market would move.

The market moved differently than what they thought it would. That is why they lost money.

Bolded is not always the case. And it wasn't in the JPM situation.

When your position is a short, things change. What the other dealers figured out was that the amount of shorts at JPM were greater than the amount of liquid longs. Here comes the short squeeze.

In order to cover thier shorts, they have to buy the underlying. But what happens if the sum of your short positions is greater than the supply of long positions? As soon as the other dealers figure this out, they start to restrict the amount of "offers" on the sell side, and then the losses start to mount.

[whisper]

Originally Posted by Eimon Gnome

Bolded is not always the case. And it wasn't in the JPM situation.

When your position is a short, things change. What the other dealers figured out was that the amount of shorts at JPM were greater than the amount of liquid longs. Here comes the short squeeze.

In order to cover thier shorts, they have to buy the underlying. But what happens if the sum of your short positions is greater than the supply of long positions? As soon as the other dealers figure this out, they start to restrict the amount of "offers" on the sell side, and then the losses start to mount.

Sorry, this doesn't contradict what I said in the size is only relevant to scale of the loss.

With the size of their position in relation to the liquid longs, it shows:
1.) They may be very wrong in their position.
2.) They are taking on a lot of risk in their position.
3.) If they were actually doing this as a hedge, their hedge strategy is flawed because the execution added risk. Analysis without judgment isn't valuable.

[Eimon Gnome]

My understanding is that JPM was actually trying to develop a market for a default index on corps. This means they were the supplier of liquidity.

Its not really a position in the traditional meaning of the word. My take is that the liquidity needed became too large - and the short squeeze brought the whole thing down.

Size most definitely matters on a short position. Ignore this at your peril. If other dealers get wind of your need to cover shorts - expect them to put the screws to you.