Wall Street: Naked and Massive Betting
In options market trading I have always wondered why naked Puts are allowed as transactions. Naked Puts mean I don’t own the underlying stock but I am guaranteed being able to sell it at a fixed price up to a fixed date. Why the transaction? If I own the underlying security and want to fix a future selling price- all well and good. This is a hedge or insurance against taking a big loss if the stock takes a downturn. For a fee I limit my losses on the stock or commodity in question. But if I don’t own the stock or commodity in question I am just gambling.
Andrew Ross Sorkin raises this question today in the NYTimes regarding the recent legal action against Goldman Sachs . Andrew asks why are synthetic CDOs , in which neither contracting party has ownership in the underlying securities [they are both naked] – why are these instruments allowed to be traded? What social purpose do they serve? And given the massive derivative betting taking place and the consequences [think AIG's massive bailout] why not prohibit synthetic CDOs and other naked derivative trading?
But Andrew does not stop here - he also raises fundamental fiduciary trust questions surrounding the Goldman Sachs market making activities in question. Should a market maker be allowed to assemble an investment that is designed to fail? Goldman is currently hiding under the guise that their client investors were sophisticated and should have done due diligence not trusting Goldman to supply them with a fair bet. Wall Street, without even trying, looks uglier and uglier every passing day. In sum, the article is a must read for the clarity of its questions and explanations of what is at stake in financial and particularly derivative reforms ongoing now in Washington.
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