In the movie Margin Call,
which was apparently inspired by the collapse of Lehman Brothers that
precipitated the Global Financial Crisis, a young analyst (Zachary Quinto),
discovers that the firm is massively overexposed to Mortgage Backed Securities
(MBSs). It had made a lot of money on these in the past.
The tension builds nicely
when a crisis meeting is called involving, among others, various members of the
risk department. Ramesh, played by Aasif
Mandvi, obviously here for his mathematical abilities, utters the
immortal words – “….I’ve just been looking here a little closer, and it’s these
VAR numbers that are really setting this thing off”.
VAR stands for “Value At Risk”
and is a well used method of quantifying the hazard attached to the positions
that any trading entity might have at any particular time. The irony in their
use at this stage in the movie is that it is far, far too late in the day to
coming to such a conclusion. If the tool was being used in any meaningful way,
the “VAR numbers” would have triggered wholesale risk amelioration measures a long
time before.
There are many scholarly
papers available for VAR, and most of them delve deeply into the concepts of
Standard Deviation, Normal Distribution and Variance, among others. But simple
is best and we prefer to basically calculate the aggregate total exposure of
all open positions. It comes down to an exercise in adding up: Take the maximum potential loss on each open position at any time and total them all. The result must fit
within certain criteria: an absolute maximum of 2% of risk of loss on any
single position and a total risk of loss on all positions of 6%.
Is volatility back?
EURUSD had a very busy time
over the last few days, ever since the remarks made by Mario Draghi of the ECB at
his press conference earlier in the week. The volume of trading in this
instrument even suggests that it is possible a trend change might be taking
place. It is too early to say yet but the situation will be monitored.
The Gold contract (chart above),
which we entered for a short period yesterday, showed serious bi-directional volatility,
to the extent that we decided to get out with a small profit rather than
undergo the kind of “whipsawing” that this kind of activity can give rise to.
Other pairs, such as USDJPY,
are still going sideways, but we are positioned for the possibility that next week this particular instrument will break out of its range.
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