Fortress Flight-to-Quality

Photograph by Melissa Golden/Redux

In 1992, [Bruno] Dupire presented the seminal notion of a two-dimensional volatility process. Between one point and another in space (spot/strike) and time (to expiration) there is a volatility implied by both the skew and the forward-forward volatility in the market.

—Nassim Taleb, Dynamic Hedging: Managing Vanilla and Exotic Options (1997), page 344.

[U]sing a collar strategy takes the return from the probable to the definite. That is, when an investor owns a stock (or another underlying asset) and has an expected return, that expected return is only the mean of the distribution of possible returns, weighted by their probability.

Wikipedia, “Collar (finance)”

And then, there are those pesky forward-forward possible returns.

My gut reaction upon watching the headlines at Marty Schenker’s desk was one word. Collar. Run as fast as you can from the above definition and that skewed word, definite.

I will defer to Bruno Dupire, of Bloomberg LP, or Nassim Taleb, unfooled by outliers, to describe the mass needed to unhinge the assumed definite hedge.

I will defer, with respect, to Otis Bilodeau and all of Bloomberg News Finance who were way, way out front on the aircraft carrier-sized mass, simple mass, that was, and is, J.P. Morgan Derivatives. Note, at first glance, $2 billion large comes in at near $8,000 per employee. It seems “manageable.”

James Dimon said all that needs to be said … for now. His shop will survive and prosper; others, weighted by their probabilities, will drown.

I have no clue what has happened since March 31 to J.P. Morgan Derivatives and the august, assembled Synthetics in London, New York, and points unknown.

What has definitely moved? The few full-faith-and-credit left standing. (See the Finland 10-year.) These are the anchors to any simple or sophisticated belief. They have shifted and have an inertial force to drag the aircraft carrier in harm’s way.

Fortress Dimon, Fortress Financial-Engineering, and Fortress Liquidity have been set adrift by Fortress Flight-to-Quality. Discuss.

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