I thank an anonymous reader for presenting the missing piece of the puzzle, and taking the convexity argument one step further from merely structured finance to the entire market. I welcome responses and apologize for the thematic wonkiness, however there is only so much simplification that can be presented. But a simplified attempt: we have crossed into territory where the negative convexity consequences of delta hedging will keep on pushing the market in a straight line in whatever direction it is moving until we see a violent reversal and the delta hedge breaks due to lack of vol to "feed it", which will be, in the parlance of our times, the market's epic fail.
What is good for GS is good for US... Young analysts, just starting in GS the London office not too long ago were told that delta hedging of equity derivatives books can account for up to 30% of market volumes. TD's data clearly demonstrates that vanilla, slow money are being swamped by quant props.Sphere: Related Content Print this post
Delta hedging of GS, DB, BNP and other dealers listed/OTC equity derivatives books could be what others construe as a 'sinister plot' to goose up US markets. OTC derivatives are many times bigger than listed and often hedged on listed markets. Clearly many books got caught short upside gamma and that will force them to buy indices and individual names as market goes up. The higher the market goes, the more they need to buy. Markets are getting too small for all the large players to operate efficiently. All of them need to get smaller or some will die.
TD's ideas and data can be taken further and what started as low level liquidity provision issues expanded into market neutral quant problems and spilled in derivatives creating a self-feeding process. More quant problems leads to further short covering, higher markets, further delta hedging, more vanilla, slow money getting sucked in and ever sunnier CNBC commentators and Time magazine contributors. Until, as TD puts it, it doesn't.