A Rumor Is One Thing That Gets Thicker Instead Of Thinner As It Is Spread

have swirled for days,
perhaps even weeks, that a number of high-profile option-specialist firms are in trouble. The trading floors of the CBOE & CME are
rife with talk of $500 million to $1 billion losses being suffered by one or
more of the largest derivative units. As nasty as that prospect is, keep in mind
that I said “being suffered” in present tense, rather than suffered in past
tense. The clear danger being that it ain’t over yet.

Because of the extreme leverage option market makers and specialists enjoy
(anywhere from 20:1 to a mind-blowing 500:1) a mistake, or stubbornness to cover
on the part of a big player can quickly become a disaster of almost biblical
proportion. In case you need a more graphic indicator, keep in mind that it took
an intervention by the Federal Reserve to save us when LTCM saw its leveraged
positions go against it.

Those of you that routinely trade on margin will have some empathy with the
leverage that we active practitioners use on a daily basis, but believe me, that
understanding is extremely limited. It is my wish for all of you that you never
fully understand the pressure of a fully leveraged portfolio of options, stocks
and futures all going against you. To say anyone who hasn’t traded with
specialist margin would understand how that feels is about as preposterous as
this Doctor J playing one-on-one with Larry Bird at TradingMarkets 2001 in Las
Vegas this October (Eddie Kwong actually brought this up this morning!) You can
only imagine the carnage!

That said, these rumors seem blown out of proportion as only Wall Street can do.
I’m sure some of the largest specialist and trading units are feeling pain, as
the volatility has been crushed on the heels of the market’s recent run-up.
After all, we began May with the Nasdaq volatility trading over 85%. Last
Friday, ahead of the lengthy holiday weekend, that same index was showing vols
of just 52%, a drop of over 38%! I’m sure big specialist units were creamed by
that volatility contraction, but I doubt it was drastic enough to wipe out the
monstrous profits these same firms booked last year and in the first quarter of

I think a more likely culprit to the market’s selloff is the bull’s old
nemesis, overconfidence. As my friend and fellow TradingMarkets commentator
Goran Yordanoff said in yesterday’s column ("The Sun Also
"), the lack of
fear as measured by the Nasdaq volatility (VXN) could signal a big move to the
downside. I’m not saying some big players aren’t hurting, but the current
pop of the VXN back to 61% should provide some relief and also moves us back
away from the overconfident levels of the VXN. Also, when it comes to rumors,
keep in mind another old Wall Street proverb, “Buy on the rumor; sell on the

Negative NDX $ weighted put ratios



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