While in Greenwich Ct. one afternoon I will never forget a conversation I had with a leading quantitative portfolio manager. He said to me that despite its obvious attributes “Black Box” trading was very tricky. The algorithms may work for a while [even a very long while] and then, inexplicably, they’ll just completely “BLOW-UP”. To him the most important component to quantitative trading was not the creation of a good model. To him, amazingly, that was a challenge but not especially difficult. The real challenge, for him, was to “sniff out” the degrading model prior to its inevitable “BLOW-UP”. And I quote his humble, resolute observation “because, you know, eventually they ALL blow-up“…as most did in August 2007.
Like navigating busy Southern California freeways, volatility option trading is path dependent: Whether one makes or loses money depends on the path taken from point A to point B – as well as what happens en route. As with the freeways, bypassing traffic and finding an optimal route can make a big difference. As a real world example, driving to downtown Los Angeles from Newport Beach can take anywhere from 45 minutes to four hours depending on the route and road conditions (such as, perhaps, unexpected construction). It’s a dynamic process, as volatility – or “traffic” – can create more volatility.
Bill Gross on liquidity :
While private equity and hedge funds have built-in “gates” to prevent an overnight exit, mutual funds and ETFs do not. That an ETF can satisfy redemption with underlying bonds or shares, only raises the nightmare possibility of a disillusioned and uninformed public throwing in the towel once again after they receive thousands of individual odd lot pieces under such circumstances. But even in milder “left tail scenarios” it is price that makes the difference to mutual fund and ETF holders alike, and when liquidity is scarce, prices usually go down not up, given a Minsky moment.
Bill Gross on our relationship to success, the heydays of investing and Michael Jackson :
Since the early 1970s when the dollar was released from gold and credit began its incredible, liquefying, total return journey to the present day, an investor that took marginal risk, levered it wisely and was conveniently sheltered from periodic bouts of deleveraging or asset withdrawals could, and in some cases, was rewarded with the crown of “greatness.” Perhaps, however, it was the epoch that made the man as opposed to the man that made the epoch.
The bankruptcy automatically terminated the swap. Under the contract, the university was required to pay a $25 million termination fee to the now-bankrupt bank.
But at that point, there was one upside. Interest rates were volatile, but had not yet plunged. The swap was not yet deep underwater. The university was out of a gamble that looked increasingly precarious.
And last but not least,
In a decision that is still not clear, university officials decided to find another bank to provide a swap with the same terms. Deutsche Bank agreed to pay the university $31 million to reissue the swap – which officials now estimate will produce $123 million in losses in coming years.