[onlooker]

http://www.marketwatch.com/story/the-70 ... oom-theres

Calculated to be some $700 trillion which is really a guess. The article states that it is like a virus which more and more is infecting the entire system. Again, how can such an enormous sum exist and not have some bearing on the real world. Like a casino with limitless resources it seems we can continue to inflate this sum. Until as the article states this ponzi scheme or game of musical chairs comes to a halt and people start to loose confidence. Then it is literally Game Over. So for the economic enthusiasts what does derivatives really mean for the world economy? Are they the ticking nuclear time bomb referred to by one renowned investor?

[Outcast_Searcher]

http://www.marketwatch.com/story/the-700-trillion-elephant-room-theres

Calculated to be some $700 trillion which is really a guess. The article states that it is like a virus which more and more is infecting the entire system. Again, how can such an enormous sum exist and not have some bearing on the real world. Like a casino with limitless resources it seems we can continue to inflate this sum. Until as the article states this ponzi scheme or game of musical chairs comes to a halt and people start to loose confidence. Then it is literally Game Over. So for the economic enthusiasts what does derivatives really mean for the world economy? Are they the ticking nuclear time bomb referred to by one renowned investor?

The notional value of derivatives is mostly beside the point. What matters is how securely potential losses in markets comprised of derivatives are planned for and covered.

For example, all stock options are derivatives (their price being affected primarily by the price of the underlying stock). There are a HUGE number of stock options, at least on well known US stocks.

Now, is this dangerous, even though the notional value of all options is huge?

Not particularly (any more than the stock market is "dangerous" overall).

Why?

Because stock options are well understood, and there are powerful market mechanisms and formulas for pricing them. While there may be differing opinions to some extent on what stock options are worth, the approximate value isn't in question to people who understand them. Also, there are well regulated margin rules and enforcement mechanisms to ensure a trader has enough capital in his/her account to PAY for any losses stemming from options. So, options aren't inherently any more dangerous in aggregate than the stock market.

Now, a better question would be why aren't ALL large derivatives markets regulated in such a way as to ensure any losses are covered, and thus making ALL derivative risk a moot point? Given how little of substance has been done to deal with (for one example) too big to fail banks who are swimming in derivative risk, and the answer as usual seems to be: ineffective government. (Imagine that).

But don't worry -- as usual, when things go wrong the trusty taxpayer will be called upon to bail the irresponsible out.

[Pops]

Knee-jerk?
They are a time bomb.

Reality?
I have no friggin idea.

A derivative is a bet, on what doesn't matter except that you need to find a counterparty.
Another bet that offsets risk of losing on the first bet is a hedge - "hedging your bets".
Say you buy some oil futures betting on oil to rise. At the same time you make a bet with someone that will pay if oil doesn't rise, you've hedged your bet. Obviously the idea is for the cost of the bets to be less than the profit either way. You pay the hedge just like insurance, so much per insured amount per insured period.

Michael Lewis wrote The Big Short about buying this kind of "insurance" during the mortgage meltdown. You can literally bet anyone about anything and it has nothing to do with anything except the underlying "thing" sex of the next royal baby, interest rates, whatever.

The thing about derivatives is they should all really cancel each other out:
A bets B $10 that x will happen
B bets it won't and hedges with C just in case it does
C has a bet with B that x won't happen so
C hedges another contract with A who is really thinking by this time that x will happen and doubles down.

So there is $40 notional value of bets but if x doesn't happen A pays C who pays B who pays A — it is a net wash. The only thing gained is the "cost" of the hedge which is just like an insurance premium.

I think.

The problem is that because the "market" is opaque, no one knows what the real cost of any risk should be, and how many bets are in which direction, but hey, who cares if they cut each other's throats. The worst thing that can happen is if someone is asleep at the switch like AIG was in the runup to the subprime crash, they had no idea what they were doing but were just diggin the "premiums coming in to insure thes home mortgages that the rating agencies said were golden, seriously, the big ratings cos said the CDOs of chopped up leftovers from other chopped up CDOs were triple A.

They took in billions of contracts days before they went tits up.

Because of course they are good capitalists and can regulate themselves, so the US bought up all the trouble.

[onlooker]

Again I am no expert on this subject. But from what I have understood then the biggest underlying problem is the whole casino mentality of the stock markets. Also, how the most wealthy and powerful seem to have inside knowledge. No problem if it was just the rich taking from each other but the problem is caught in the middle are pension funds not to mention normal people have been suckered in by entities such as E-trade. Also, all this liquidity movement can potentially make or break a public company.

[Pops]

Again I am no expert on this subject. But from what I have understood then the biggest underlying problem is the whole casino mentality of the stock markets. Also, how the most wealthy and powerful seem to have inside knowledge. No problem if it was just the rich taking from each other but the problem is caught in the middle are pension funds not to mention normal people have been suckered in by entities such as E-trade. Also, all this liquidity movement can potentially make or break a public company.

Inside knowledge is very old school, it just doesn't matter anymore. Read some Michael Lewis, he gives great narrative. His books usually feature some heroic guys who find out some crazy scam and make a killing of the bad guys, and they are all true, or as true as such things get.
The Big Short is about shorting the subprime mortgage market using derivatives.
Flash Boys is about having a fast enough internet connection so that you have time to see when someone makes a bid on a stock, then go out and find a lower price, buy the stock then get back sell it to the original bidder at a profit ... in milliseconds. That is frontrunning and has pretty well emptied out the stock market of retail traders.

"Quants" is another good book, though not by Lewis, about writing the algos that do the trading these days in lieu of humans — there is no such thing as a trading floor anymore. Seriously, everything has changed since '99 and the end of Glass Steagall, the half assed attempts to revive it are prolly why the Clintons need another shot.

Note, I am no expert at this or any thing else and hold no positions in any issue mentioned here or the other 15,000 posts.

[onlooker]

haha, same here no expert at anything just an onlooker. One thing I am pretty sure though is the economic system is becoming more and more unstable in many ways, the stock market being one. At some point the monied class will be just one person haha.

[Keith_McClary]

A derivative is a bet, on what doesn't matter except that you need to find a counterparty.
Another bet that offsets risk of losing on the first bet is a hedge - "hedging your bets".
Say you buy some oil futures betting on oil to rise. At the same time you make a bet with someone that will pay if oil doesn't rise, you've hedged your bet. Obviously the idea is for the cost of the bets to be less than the profit either way. You pay the hedge just like insurance, so much per insured amount per insured period.
...
The thing about derivatives is they should all really cancel each other out:
A bets B $10 that x will happen
B bets it won't and hedges with C just in case it does
C has a bet with B that x won't happen so
C hedges another contract with A who is really thinking by this time that x will happen and doubles down.

So there is $40 notional value of bets but if x doesn't happen A pays C who pays B who pays A — it is a net wash. The only thing gained is the "cost" of the hedge which is just like an insurance premium.

I think.

The problem is that because the "market" is opaque, no one knows what the real cost of any risk should be, and how many bets are in which direction, but hey, who cares if they cut each other's throats. The worst thing that can happen is if someone is asleep at the switch like AIG was in the runup to the subprime crash, they had no idea what they were doing but were just diggin the "premiums coming in to insure thes home mortgages that the rating agencies said were golden, seriously, the big ratings cos said the CDOs of chopped up leftovers from other chopped up CDOs were triple A.

Yah, somewhere in the system someone is making unhedged bets against rare "black swan" events. As long as these events do not occur they collect premiums (or profits on derivative dealings) and pay themselves executive salaries and bonuses and dividends to shareholders. When a "black swan" event happens, they can't pay.

I should start an insurance company that offers coverage against massive meteorite impacts.