Make derivatives illegal now!!

[eridani]

http://www.usnews.com/opinion/blogs/economic-intelligence/2012/07/16/derivatives-should-be-banned-from-financial-markets

The idea that the financial products known as derivatives pose a danger to the financial system is nothing new. Commentators have been pointing this out for years. Most famously, Warren Buffett referred to derivatives as "time bombs" and financial "weapons of mass destruction." Recently a complex derivatives trade caused over $5 billion in losses at J.P. Morgan.

Derivatives are bets between two parties that are made today with a payoff in the future based on the value of some stock, bond, or index. One party will profit if the reference security or index goes up in value and the other party will profit if it goes down. These bets usually settle up every three months based on value at that time, and then a new calculation period begins. There are many variations on this basic pattern, but almost all derivatives involve some form of a bet in which gains and losses are calculated and settled-up periodically.

If derivatives are as dangerous as the commentators suggest, why are they permitted? If they are such a threat to the financial system, why does the size of derivatives bets continue to grow? The answers have to do with several myths the big bank derivatives players have created. These myths are false and distract interested parties from doing what needs to be done to ban derivatives. It's time to demolish these myths once and for all.

[Shemp Howard]

1. Derivatives can be useful.

I'm no expert on the matter, but I've read that many farmers use derivatives to protect their crop prices.

Say you are a corn farmer. It's early in the season, and you need the price of a bushel of corn to be at least $4 for you to make a profit for the year. But corn prices fluctuate, and come harvest time that price might be less than $4.

So you buy a derivative based on corn prices in early November. You'd buy one that pays off if a bushel of corn goes for less than $4. It's a hedge that protects you, like an insurance policy.

If the price of a bushel corn come November is more than $4, you make a profit on your crop, but lose the cost of the derivative. If the price is less than $4, the derivative pays off, and helps your bottom line.

The same argument can be made with a stock that you don't want to sell now, but in November. You'd buy a stock derivative in that case.

The problem as I see it is some people use derivatives not as insurance policies but as a gambling game. I don't see how you could stop that. But again I'm no expert on this.

[Squinch]

4. "First generation" derivatives, for lack of a better term, are useful and legitimate as hedges

against disaster. By "first generation" I mean those that are based on the movements of an actual product or an actual financial instrument based on a tangible asset.

The trouble comes when you get derivatives about derivatives: you have the derivative you describe, and then someone invents a derivative about how that derivative will behave, not any actual thing but the derivative itself. And then there are derivatives based on how the derivative of the derivative will behave.

And then we go into the real insanity where we make derivatives that never trace back to an actual asset, called "synthetic derivatives". Rather they are instruments where you can bet on an invented product, kind of like a fantasy football team. You make up whatever you like and then you start taking bets on how that made up thing will behave. This allows for unlimited money to be put into a system that backs nothing at all.

I think anything but first generation derivatives should be outlawed.

[eridani]

7. "those that are based on the movements of an actual product or an actual financial instrument--

or an actual financial instrument based on a tangible asset." Exactly. Why in fucking hell should it be legal to make bets whose total "value" is many times that of GNP?

[Travis_0004]

5. Agreed

Another example. A Canadian airline wants to buy a boeing jet. They agree to pay 200 million Canadian in 4 years when it is delivered.

That wont work for boeing, they need US currency, and cant risk loosing money if exchange rates move. They could purchase a derivative and lock in the exchange rate. When uses properly, they reduce risk.

[A HERETIC I AM]

8. What you're describing are common Commodities Futures contracts

Not only farmers use them but any buyer of any commodity traded on any exchange dedicated to such business, like the NY Mercantile Exchange or the CBOE.

If you are a farmer and want to access the market, it doesn't work as you describe, because you are the seller of the commodity. You sell a contract for future delivery at a specific strike price.

The problems arise when the buyer of the contract has no intention nor ability to take delivery of 5000 bushels of corn (or 10,000 barrels of
Oil or whatever) These types of players sell the contract before it gets exercised, speculating that the spot price will rise and therefore the contract will increase in value. Both sides of this transaction can be played.

The famous closing scene of the movie "Trading Places" illustrates this, as the two characters had neither the frozen concentrated orange juice to sell, nor did they have the ability to take delivery when they bought. What they ended up with however, was a "cornered market" in that they owned contracts for delivery and anyone that wanted FCOJ had to buy it from them at whatever price they demanded.

What Lewis and Billy Ray did was "sell short" at the beginning of the scene, that is to say, they sold what they did not own at a high price then bought to cover at a much lower price.

[Festivito]

2. On their own they should only be for individual investing. Not for retirements, not funds unless...

... unless most participants agree and each pro-D-voter in that group takes full loss for derivative loss. The total amount available would correspond to the total investment by the pro-D-voters protecting the con-D-voters from any loss due to those derivatives.

Easier to separate them into separate funds.

That's for investments in sole derivatives. Insuring a new investment where the fund has both the investment and insurance on that particular investment for up to a year is okay. Investing in derivatives of other investments not held, is a total risk and should be treated differently -- requiring full approval.

[byronius]

3. I'd love to make the leap to a Star Trek economy in my lifetime.

Spending time and resources managing money is bizarrely and almost criminally inefficient. Banking as the primary growth industry? Effing ridiculous concept. Puerile. Backward. Amazingly stupid. The intellectual capital it absorbs could have colonized the solar system by now. Masturbation, that's what it is. Profitable masturbation.

Short of replicator technology, I expect this absurdity to continue. Competition might work for very specific niches, but generally it's utterly counterproductive for the whole, duplicating efforts and consuming scarce resources all because we're still too primatey to know better.

And take advertising with it as well.

According to the canon, money disappears and makes way for a society filled with individuals all striving to be their best at whatever floats their boat.

And true, according to canon we're going to have to go through the Eugenics Wars before we get there.

I'm just impatient. Can't we just skip ahead and do this? Gag. We're so slow.

[mopinko]

6. vix

volatility index- nothing but betting on fear. and how easy is it to stir up some fear on wall street?