The Volcker Rule Doesn’t Ban Trading

Volcker.

Here’s some stuff that banks do. They call up a big investor and say: “Hey I have an idea. What if I sold you a product that gives you exposure to XYZ stock, but your upside is capped at 120 percent of today’s price, and your downside is floored at 80 percent of today’s price? Also I will lend you most of the money to do this thing.” And the investor says “ugh I don’t know that sounds complicated” and the bank says “no no no it is great trust me you will love it” and the investor says “ugh fine I guess.” And the bank signs this contract with the investor, and lends the investor a bunch of money. And then it goes out and buys some XYZ stock to deliver to the investor, and sells some XYZ stock to hedge its exposure under the structure. And then maybe it buys or sells some XYZ options to hedge its volatility exposure, or some interest-rate swaps to hedge its rates exposure, or some credit-default swaps to hedge its jump risk on XYZ. And then XYZ’s stock goes down and the customer calls and complains “I thought you said this would be great,” and the bank apologizes and offers to make it up to the customer by converting this trade into a series of knock-in options on the Swedish krona that will be more to the customer’s liking, and the customer says “oh fine go ahead,” and the bank does it and goes out and hedges by trading kronor and kronor options and a basket of correlated currencies and, I don’t know, bauxite or something as a hedge.