I don't like the term "mobile wallet" in its digital-world significance. The term refers (and I'm quoting from a banking-industry website here) to a smartphone feature that is linked to a user's credit or debit cards "to make payments in person at a physical point of sale." Got it. Not a very complicated idea. What I don't like about it is the implication that wallets had to become digital in order to be "mobile." Haven't wallets always been mobile? Hasn't that always been the point? A wallet [an "analog wallet" if I need to say that -- a wallet sans phrase] is to be carried, in a woman's purse or a man's pocket. A mobile wallet is now "in" your phone, in some sense of that flexible preposition. I don't really see a significant gain in mobility there. Anyway, the reason for bringing it up is that Apple has now jumped on the mobile-wallet bandwagon. The iPay system, the new mobile phone a...
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Debt is traded very differently from most corporate equity. The secondary market for bonds gets along without the big listed exchanges that provide a central narrative in the world of corporate stock. Indeed, for a long time trades were negotiated and agreed upon through telephone calls. In the 1990s, it occurred to various pioneers that “we could use the internet for this” and they tried to create an exchange-like model, an anonymous central limit order book (CLOB). A company called Trading Edge created BondLink for this purpose. Perhaps a related development: in 1998, the chairman of the Securities and Exchange Commission at the time, Arthur Levitt, said in a speech at the Media Studies Center in New York, “Investors have a right to know the prices at which bonds are being bought and sold. Transparency will help investors make better decisions, and it will increase confidence in the fairness of the markets.” Well, more transparency is always greater than less if the d...
"Most traders think there are two types of trades: winning and losing. Actually, there are four types of trades: winning trades and losing plus good trades and bad trades. Don't confuse the concepts of winning and losing trades with good and bad trades. A good trade can lose money and a bad trade can make money. A good trade follows a process that will be profitable (at an acceptable risk) if repeated multiple times, although it can lose money on any individual trade." - Jack Schwager
The above graph is a visual representation of the Black-Scholes model. Or Black-Scholes- Merton if you want credit shared equitably and "you're not into the whole brevity thing," Mr Lebowski. As you can see, there are three axes. The x axis (the width of the box) is the price of the underlying asset, the stock price, treating the strike price in the center as 1. The y axis (the height of the box) is the volatility of that option. The z axis (the depth of the box) is the time to maturity [and either exercise or expiration]. As you can see, the plane of various shades of blue (the darker the blue, the higher) has a sharp crease at the front/center/bottom of the box, where the sharp difference between winners and losers on the lottery’s drawing date is indicated. We should also mention that the volatility that goes into the calculations as we’ve described them above is historical volatility. One of the assumptions of the BSM model is constant volatilit...
You’ll remember that in earlier posts I've discussed a hypothetical widget-making company, XYZ, and said that we could enter various reasonable assumptions about this company’s stock in a calculator available in any of several websites, and receive for our troubles the value of a proposed put or call. How does the calculator do that? A skeptic may sneer at the whole idea and say, “only supply and demand determine the value of a financial instrument. The demand for an option on a particular stock may change from day to day – as may the supply, as new writers enter or leave the market – so surely no formula or algorithm can tell us in advance what the value is.” That’s a plausible response, but it is in error. The value of stock options can be defined mathematically in ways that the value of the underlying stocks cannot. After all, we know intuitively what the value of a stock option is on the expiration date. If it has expired worthless, we know the value i...
We'll resume our discussion of stock options from where we were here. The above photographed felon will come into our discussion soon enough. Options can be part of broader strategies that limit exposure in either direction. You can combine puts and calls to create a “collar” around the market price of the underlying stock, limiting both your own profit and your own risk. The word “straddle” has connotations similar to “collar,” suggesting that options allow the straddler to be on both sides of the same underlying asset at the same time. Yet “straddle” has a more aggressive sound to it. As it happens, Bernie Madoff used to tell prospective clients that he was following an options-based straddle strategy. Of course, he wasn’t following any strategy, but he needed to sell a story, and that was it. Such a straddle strategy, by the way, can work when carried out legitimately. It can do roughly what Madoff claimed that he was using it to do – produce a slow-but-...
I said a few posts back that in order to understand the assumptions behind the efficient capital markets hypothesis (ECMH), it will help us to state the case for that hypothesis with some clarity. Here we go: when there is a way for someone to make alpha, that way comes about because there is some exploitable inefficiency in the system. For example, XYZ may be listed on stock exchanges in two cities: Philadelphia and Pittsburgh. Due to some inefficiency, XYZ trades at a lower price in Philly than in Pittsburgh. We know that’s inefficiency because the equity of XYZ is worth only what it is worth; there is only one possible complete discounting of all relevant information on that matter. If Pittsburgh and Philadelphia differ, one or both are wrong. Since listed exchange prices are themselves public information, arbitrageurs will almost instantly pickup on this, and will quickly start buying XYZ at the lower price in Philadelphia and then selling it for a risk-free profit for a hi...
One of the central elements in modern finance theory is that of a risk-return tradeoff. The idea is simply that investors are risk averse, and accordingly must be paid to incur risk. T here is, then, a constant trade-off in the investment world: safe investments carry low return, high-return investments aren’t so safe. Fortunately, this conforms with almost everyone’s intuitions. What exactly is risk, though? Yes, we have an intuitive idea. The guy jumping out of an airplane is taking a risk that the appreciative audience standing on firm ground below is not. Further, if he has neglected to check his gear properly he is taking an extra, unwarranted, risk. But we can be a good deal more specific about what the word means in the world of investments. It means the size of the standard deviation of return. It means the width of that bell curve we've discussed in earlier posts. Standard Deviation A standard deviation is the “average distance from ...