A “short squeeze” sounds innocuous enough... • Hacker News Board

Re: A “short squeeze” sounds innocuous enough...

#31

Post by 1gor » Thu, Jan 08, 2009, 5:38 PM UTC

eli wrote: post #28

nradov wrote: post #25

Earlier quoted context omitted.

Why would the German government care about what happens to hedge funds who get screwed by speculating with stupid unhedged short bets in the secondary market? That has no relationship to actual investing in German companies.

Note that "hedge funds" is kind of a misnomer. A hedge fund is just like any other fund, except that it's less regulated and exclusively for rich people (the thinking being that rich people need less gov't regulation over their money because, well, they're rich). They don't make money by literally "hedging their bets."

> exclusively for rich people

No, it is not. The California Public Employees’ Retirement System (Calpers) alone had more than $10 billion invested in hedge funds in 2007.

So your average Joe should not wish evil to hedge fund managers, his retirement money is at stake.

Re: A “short squeeze” sounds innocuous enough...

#32

Post by nradov » Thu, Jan 08, 2009, 5:41 PM UTC

jayp wrote: post #26

nradov wrote: post #25

Earlier quoted context omitted.

Why would the German government care about what happens to hedge funds who get screwed by speculating with stupid unhedged short bets in the secondary market? That has no relationship to actual investing in German companies.

I am not sure you understand how hedging works. You don't go short and long on the same stock to hedge. You generally take one position (long or short) on the stock you are speculating on, and you take the opposite position with stocks in its peer group to protect against swings in the industry. The basis of the hedge is that stock performance is correlated within sub-industry. With a short squeeze like the one of VW…

No, I understand exactly how it works. If you take a short position by borrowing a stock there is always a small but non-zero risk of completely blowing up due to something like this. It's playing financial Russian roulette. Making the market more transparent reduces the risk a little more, but it's still non-zero.

Any trader with common sense would have hedged the downside risk using other derivatives. For example, he could have purchased enough deep out-of-the-money call options to cover all the shares he borrowed.

No one is suggesting that shorting or speculation ought to be banned. However I remain unconvinced that requiring Porsche to immediately disclose their VW ownership stake in this case would have had any benefit for the German economy as a whole.

Re: A “short squeeze” sounds innocuous enough...

#33

Post by nradov » Thu, Jan 08, 2009, 5:50 PM UTC

1gor wrote: post #31

eli wrote: post #28

Earlier quoted context omitted.

Note that "hedge funds" is kind of a misnomer. A hedge fund is just like any other fund, except that it's less regulated and exclusively for rich people (the thinking being that rich people need less gov't regulation over their money because, well, they're rich). They don't make money by literally "hedging their bets."

> exclusively for rich people No, it is not. The California Public Employees’ Retirement System (Calpers) alone had more than $10 billion invested in hedge funds in 2007. So your average Joe should not wish evil to hedge fund managers, his retirement money is at stake.

Alternatively, perhaps CalPERS shouldn't be risking average Joe's retirement money by putting money into unregulated speculative investment pools. There's no reason to expect that hedge funds will deliver superior risk-adjusted returns compared to any other asset class. And there are some really horrible structural problems with most hedge funds which make them poor choices for pensions.

Re: A “short squeeze” sounds innocuous enough...

#34

Post by op12 » Thu, Jan 08, 2009, 6:08 PM UTC

nradov wrote: post #32

jayp wrote: post #26

Earlier quoted context omitted.

I am not sure you understand how hedging works. You don't go short and long on the same stock to hedge. You generally take one position (long or short) on the stock you are speculating on, and you take the opposite position with stocks in its peer group to protect against swings in the industry. The basis of the hedge is that stock performance is correlated within sub-industry. With a short squeeze like the one of VW…

No, I understand exactly how it works. If you take a short position by borrowing a stock there is always a small but non-zero risk of completely blowing up due to something like this. It's playing financial Russian roulette. Making the market more transparent reduces the risk a little more, but it's still non-zero. Any trader with common sense would have hedged the downside risk using other derivatives. For example,…

Not every trader could have just hedged out the risk of a blowup. that is becuase derivatives are a zero sum game. For every trader who purchased the out of the money call, someone sold it. Therefore that person is now responsible for unlimited downside.

Re: A “short squeeze” sounds innocuous enough...

#35

Post by 3pt14159 » Thu, Jan 08, 2009, 6:12 PM UTC

sh1mmer wrote: post #7

This is a brilliantly clear explanation.

While the explanation is clear, it should address the simple steps these hedge funds should have taken to protect themselves.

The hedge funds knew that VW was largely owned by big institutional investors. They knew Porsche was interested in owning VW. They may have had good reason to short VW, but if they were going to do that, why didn't they just buy some cheap, far out, short term call options that would have protected themselves from the divide-by-zero problem? The purchase would have been far smaller than their potential profits had they been right about VW declining like GM, Toyota, etc.

Re: A “short squeeze” sounds innocuous enough...

#36

Post by nradov » Thu, Jan 08, 2009, 6:28 PM UTC

op12 wrote: post #34

nradov wrote: post #32

Earlier quoted context omitted.

No, I understand exactly how it works. If you take a short position by borrowing a stock there is always a small but non-zero risk of completely blowing up due to something like this. It's playing financial Russian roulette. Making the market more transparent reduces the risk a little more, but it's still non-zero. Any trader with common sense would have hedged the downside risk using other derivatives. For example,…

Not every trader could have just hedged out the risk of a blowup. that is becuase derivatives are a zero sum game. For every trader who purchased the out of the money call, someone sold it. Therefore that person is now responsible for unlimited downside.

Exactly. And if you can't hedge at a reasonable price then you shouldn't make the trade in the first place. Also, if the call seller is covered then he only has a small downside.

Re: A “short squeeze” sounds innocuous enough...

#37

Post by eli » Thu, Jan 08, 2009, 6:58 PM UTC

1gor wrote: post #31

eli wrote: post #28

Earlier quoted context omitted.

Note that "hedge funds" is kind of a misnomer. A hedge fund is just like any other fund, except that it's less regulated and exclusively for rich people (the thinking being that rich people need less gov't regulation over their money because, well, they're rich). They don't make money by literally "hedging their bets."

> exclusively for rich people No, it is not. The California Public Employees’ Retirement System (Calpers) alone had more than $10 billion invested in hedge funds in 2007. So your average Joe should not wish evil to hedge fund managers, his retirement money is at stake.

I did not mean to imply otherwise.

But yes, I should have been clear: rich people and rich organizations.

Re: A “short squeeze” sounds innocuous enough...

#38

Post by potatolicious » Thu, Jan 08, 2009, 9:14 PM UTC

eli wrote: post #27

markessien wrote: post #23

Earlier quoted context omitted.

Not before "investing". Before speculating on the shares of companies in the region. The investors are only the people who purchase the stock as sold from the company - and those people have nothing to lose by this affair.

I don't quite follow. Isn't buying shares de facto "investing" ? (You may have a point on the shorting of shares, but that serves a purpose too; to devalue overpriced assets)

I think he's making a distinction between "classical" investment and Wall Street-style investment (for lack of better terms). There's an ideal that an investor puts money into a business that he thinks has potential to succeed (e.g. VC funding), and reaps his rewards through the success of the business.

Then there are others who invest purely as stock price speculation, and is generally disinterested in the actual goings-on of the business beyond what is likely to impact short-term stock price.

Re: A “short squeeze” sounds innocuous enough...

#39

Post by sam_in_nyc » Thu, Jan 08, 2009, 9:41 PM UTC

patio11 wrote: post #18

sam_in_nyc wrote: post #10

Earlier quoted context omitted.

What happens in the case of an "infinite squeeze" where the party who owes stock to another cannot pay it back? Is this a risk the lender has to deal with, that they may not ever see the stock they lent out again because the party they lent it to squandered it? Seems to me in the "short squeeze" situation the value of the stock cannot be infinite -- it is bound by the terms of the contract to which the shares were le…

You will forfeit whatever you posted for collateral. For a retailer investor, that might mean a margin call causing you to liquidate what you held with your brokerage. There are safety requirements (imposed by the government and your brokerage) to make sure you cover the liability. But when you're talking about billion dollar bets, you probably didn't fully secure it. Nope, you put your reputation up for collateral i…

Very informative. It comes down to reputation.

Re: A “short squeeze” sounds innocuous enough...

#40

Post by eli » Thu, Jan 08, 2009, 10:26 PM UTC

potatolicious wrote: post #38

eli wrote: post #27

Earlier quoted context omitted.

I don't quite follow. Isn't buying shares de facto "investing" ? (You may have a point on the shorting of shares, but that serves a purpose too; to devalue overpriced assets)

I think he's making a distinction between "classical" investment and Wall Street-style investment (for lack of better terms). There's an ideal that an investor puts money into a business that he thinks has potential to succeed (e.g. VC funding), and reaps his rewards through the success of the business. Then there are others who invest purely as stock price speculation, and is generally disinterested in the actual go…

I see what you're saying, but I don't perceive a meaningful difference between those two classes beyond, perhaps, what's in the investor's head.

In both cases you're investing money in a company because you think the value of that company is likely to rise in the future. And in both cases the company benefits from that investment.

I agree that many investors are too focused on the short-term... but if they think they can make more money by selling a stock and reinvesting elsewhere rather than holding onto it for years, can you really blame them? The whole point of investing is to make a return on your principal.