Hope you got your francs before today.

Photographer: Chris Ratcliffe

Levine on Wall Street: FX Fallout and the Value of Volatility

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Franc fallout.

So ... how's your foreign-exchange trading going? Yesterday's pick-a-number-standard-deviation move in the Swiss franc "caught everyone off guard," "sent the markets into a tailspin," is "likely to create more volatility in the short term," and left a lot of people very embarrassed or broke:

Anthony Peters, a broker at Swiss Investment Corp., said firms that were selling options tied to the Swiss franc may be among losers. They would have lost money as volatility surged.

“Selling puts or vol on the franc was deemed to be SNB guaranteed money for old rope,” he wrote in a note to clients. “There will be some very red faces around as it begins to transpire who should not have been playing that game.”

One-week implied volatility shot up vertically from, like, 3 to something over 25 percent. This naturally reminds me of my favorite FX volatility story,  from Nassim Taleb's "Dynamic Hedging," the moral of which is, be careful selling teenies against an exchange rate that's being protected by a central bank. Sometimes they stop!

A lot of people have just plain blown up already. FXCM Inc. "said clients owe $225 million on their accounts," and it "might have breached regulatory capital requirements" because of the client losses. Global Brokers NZ Ltd. seems to have been washed away, as was Alpari (UK) Limited. there are catastrophes left and right. Also, Deutsche Bank and others were "among the foreign-exchange dealers to suffer disruptions to electronic trading of the Swiss franc as the currency unexpectedly soared," and Saxo Bank wants a do-over on some of its client fills. Meanwhile the Chicago Mercantile Exchange announced that it will double, then triple, margin on Swiss franc futures contracts.  As I read this, you used to have to maintain margin of at least $2,250 against a CHF 125,000 futures contract; that number is going up to $6,750, or 5.4 cents per franc, or ... well, around one-third of yesterday's move. So even that tripled margin will only get you so far. 

Elsewhere in red faces, poor Goldman Sachs was stopped out of one of its top 8 trade ideas for 2015 halfway through January at a 16.5 percent loss. The trade was short Swiss franc/long Swedish krona, and it did pretty much as poorly as the short franc/long euro trade that the Swiss National Bank stopped itself out of the previous day.

One other small point. Swatch Group has been particularly vocal in its sadness about the strengthening franc, causing Matt Yglesias to say on Twitter that "Listening to all the Swatch whining is a striking reminder that exporters never seem to actually hedge FX risk." But Swatch does: Its latest annual report, from December 2013, shows forward contracts (on foreign exchange and precious metals) with a total notional amount of 1.5 billion francs (page 213). Hedging can reduce your volatility in the short or medium term, but no one hedges the exchange-rate risk on the entire amount of their future sales. (How could you?) Similarly, many oil companies hedge the oil price, but they might do that by hedging half of next year's production and a quarter of the following year's, not all of the oil that they'll ever get out of the ground. If you're naturally short francs, or long oil, then a sharp and long-term move up in the franc, or down in oil, will be bad for you in the long run, even if you're so fully hedged that it's profitable in the short run.

On the other hand, we should "stop worrying about Swiss franc mortgages in Poland," so that is good news. And whatever your feelings on the Swiss franc, the euro project, and FX volatility generally, probably stay away from Iraqi dinar scams

Speaking of volatility.

The banks that have reported earnings so far have rather underwhelmed in the trading revenue department, given last quarter's choppy markets. This has led to a certain amount of pointing and laughing, because those same banks were previously complaining that they couldn't make money because the markets were so quiet. But see:

“Volatile volatility, these extreme moves, tend to drive people to the sidelines because nobody is able to take a view as to how they should be protecting their business,” Citigroup Chief Financial Officer John Gerspach said today on a conference call with journalists. “When you get these sudden swings, people don’t know what to do, activity just stops.”

If you run the casino, you don't want the games to be boring, but you don't want them to be terrifying either. 

Goldman had earnings.

Here's the press release, with earnings per share of $4.38 for the fourth quarter, a bit above expectations of $4.32. Revenue of $7.69 billion also beat slightly. Compensation expense for the year was $12.69 billion, or 36.8 percent of revenue, basically flat to 2013 on a 3 percent bigger staff. That staff is 34,000, so around $373,000 each.

Active vs. passive.

One weird thing that you could worry about is that index funds have a tragedy-of-the-commons element to them. The smart thing for most small investors to do is invest in index funds, because they guarantee market-average performance at below-average fees, whereas actively managed funds will on average have average performance (or worse!) with above-average fees. But if everyone does that, then there's no one actively managing money, and markets won't be efficient, and your index fund will be terrible. I have sometimes worried about just that, but here indexing evangelist Burton Malkiel puts my mind at ease (via Paul Kedrosky):

Indexing could double from present levels and there would still be plenty of active managers at work. Indeed, even if active investors and traders made up only a small proportion of market participants, as long as any opportunities for arbitrage profits existed, traders would undoubtedly fill the gap. Active investors would continue to participate in the market so as to ensure that all available information became reflected in market prices. As indexing has grown rapidly over the past two decades, there is no evidence that the market has become less efficient. On the contrary, the proportion of outperforming active managers has become smaller rather than larger.

Elsewhere, "Only 37% of BlackRock’s active equity products were performing above their benchmark or peer median over one year, down from 51% at the end of 2013." And in bonds, "Unconstrained funds, part of a new breed of mutual funds designed with the flexibility to profit in rising and falling markets, returned an average of 1.2 percent in 2014, compared with 5.2 percent for intermediate-term funds, historically the most popular bond investment."

How's the Dollar deal going?

Here's Dollar General's "update on the status of its discussions with the Federal Trade Commission" about its efforts to buy Family Dollar, and it is grim stuff. The words "prepared to defend litigation if necessary" come up. Against the FTC! Over its antitrust review of the proposed offer! "Dollar General was seen by analysts as conceding defeat" in this statement, which didn't offer a price bump or really anything else, and it is hard to disagree. But imagine being the antitrust lawyer who's still working on Dollar General's document submission just to, like, keep up appearances. The way to concede defeat is to be like "never mind, we're going on vacation." But, no, Dollar General is conceding defeat by continuing to tell Family Dollar shareholders to tender into its offer, but just "not giving the Family Dollar shareholders a lot of good reasons to choose its deal." Anyway, Family Dollar's shareholders vote on the Dollar Tree deal next week, and it does rather seem like the winner.

Today in bitcoin.

I am not really following the Silk Road trial, but it sounds like a hoot, with Ross Ulbricht's lawyers arguing that the guy who ran bitcoin exchange Mt. Gox (into the ground, it is hardly necessary to add, given that it was a bitcoin exchange) also ran Silk Road and framed their client. This sounds like a crazy conspiracy theory except that the government agents ... did not entirely disagree? Also, here is a story about media in New York that you may enjoy if you are a journalist or a lawyer or a subway commuter.

Things happen.

Basically every securities law professor thinks that Daniel Gallagher and Joseph Grundfest should take back the mean things they said about Harvard's Shareholder Rights Project maybe violating the securities laws (previously). European Commission lays bare Amazon tax deal with Luxembourg. A microcap mining scam. RadioShack Said to Be in Talks to Sell Stores to Sprint. Here is Mike Konczal's "Battle Map for the Republican War Against Dodd-Frank." Here is the New York Fed on Andy Rooney on bank names. "Lexington Steele: My Wall Street background helped me make it in the porn industry." Vitamin C is a hoax.

  1. Though to be fair I'd be hard pressed to think of a second-favorite FX vol story.

  2. Disclosure: I worked there, and still own a little restricted stock, though it should un-restrict soon and then this disclosure will get shorter.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net