Monday, 31 January 2011

Increasing the Margin

There was a link on one of the forums here to a story about a hedge fund manager who recently liquidated a large Gold spread position. It seems that with a relatively small amount of money ($10 Million hedge fund), the hedge fund accumulated a "$850 Million" position. While the characterisation of the size of the trade as $850 million may not be a correct description of the amount of gold held on a directional basis, it none the less shows that this guy was holding a highly leveraged spread position.

The spread went against him. I've had option spreads go against me too. I then evaluate what will happen between the now and expiry and make a decision. What seems to have happened here was that the clearing house decided that the margin needed to be increased. The increase was of such a magnitude that the hedge fund's cash investment would have needed to be multiplied. The position was closed, the hedge fund made a loss in excess of it's drop dead level and was closed down by the operator and what money was left was returned to investors.

The story reminded me of a number of things I have strong opinions about:

1. I need to directly look after my own investments rather than outsource. To do this I need to make sure I have educated my self sufficiently to do a good job. There should be no one who you trust more than yourself with your own money.
2. Markets can stay out of line a lot longer than I can stay solvent. Don't fight the market. Being right in the long run doesn't mean anything if I can't hold the position comfortably in the short run. If something strange is happening, cut and run, and re-evaluate. There was an old stockbroker called Stanley R Johnson who, (must have been over 40 years ago now), taught me "the best loss is your first loss". Stan was of the old school of broking and died from a heart attack in the office one day at the age of just over 60 having just remarried.
3. Remember that smart people act in their own best self interest. During the previous Gold and Silver boom that ended in about 1980 after the Hunt Brothers tried to corner the Silver market, members of Comex found themselves short a lot of gold and silver as the market went up and up. Increasing margins didn't stop the Hunts as they were, then, richer than Croseus. Comex ended up making a rule change prohibiting opening of new positions. Only liquidation was allowed. Gold and Silver crashed, the Hunts were toast. This was my second experience of "tulip mania". I've seen a few more since and I'm sure that there's a lot more to come.

I had ES expectations for today that were not realised. The ES dipped overnight before London woke up. I tweeted that I tried to sell the early highs but the market didn't co-operate. I also tweeted that I would sell against 1279ish if the flow turned down. I ended up with a couple of OK trades as the vid shows, but the market didn't oblige and rather gave us the usual after a hard move down - consolidation.

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