Ready, set, grow: educate yourself in financial literacy month
April is financial literacy month in the United States. CNBC is promoting a month-long series called “Invest in You: Ready. Set. Grow.” to feature accessible personal finance education content for the next generation.
I encourage readers to have a look – use those tips and information to feel good about managing your finances.
Meanwhile, a few weeks ago, we read about the Gamestop phenomenon, where investors employed the ability of their broker to sell stocks they did not own, in order to short them, or bet that the value of a company’s publicly traded stock falls in value.
Shortsellers will profit by purchasing the now-decreased value stock (with the proceeds of the short sale) thereby replacing the stock that they never owned. The difference in the sold and repurchase price is the profit. Of course, if the stock valuation climbs higher than the borrowed sale price, the shortseller loses – in some cases, very bigly. In both cases, the shortseller also must pay the broker short interest – that can fluctuate depending upon activity. Short-selling is employed regularly in investment circles.
One reader noted it appeared that more small investors were trading options rather than shortselling. Moneywise will cover options in future investment week article.
Today, however, we discuss on a very basic manner how an investor can use the value of a security by borrowing against that value determined at a certain time, then employing derivatives to leverage up in say 5:1, 10:1, possibly further ratios.
Equity swaps and contract-for-difference (CFDs) are two advanced leveraging strategies used by experienced traders.
What is a CFD?
It is an agreement between an investor and a CFD broker to exchange the difference in the predicted value of a financial product between the time the contract opens and closes. If the underlying asset price moves upward, the investor gains; downward price favours the broker. CFDs have no expiration date, they are just basically renewed (rolled) at each trading day close.
No underlying assets are owned thereby costs are easy to execute with either long or short positions.
Naturally, there are risks including weak industry regulation (CFDs are illegal in the US and Brazil), lack of liquidity can be problematic, and adequate margin accounts must be maintained.
CFDs were initially used by hedge funds and institutional traders to cost-effectively gain an exposure to stocks on the London Stock Exchange, partly because they required only a small margin but also, since no physical shares changed hands, it also avoided stamp duty in the United Kingdom.
Equity swaps are a similar derivative strategy – the general differences are that CFDs can be used for various securities: stock, currencies, commodities, etc, while equity swaps are limited to just that, and have a fixed, pre-decided time frame.
One name figured vividly in finance news last week, a private family office firm called Archegos Capital Management owned by Bill Hwang, who previously worked for Julian Robertson, the legendary hedge fund manager and owner of Tiger Management.
The name, Archegos, appears to be based upon Greek terminology that can be interpreted in English language dictionaries as chief, founder, leader, originator, and trailblazer. However, as the billions of dollars of losses in this narrative unfolded, perhaps, separating the word into Arch Egos, may be a more apt description.
According to MoneyStuff – Matt Levine’s Bloomberg Opinion column, Archegos “extracted as much leverage as possible from a half dozen Wall Street banks to buy a concentrated portfolio of tech and media stocks (apparently partially hedged with short index positions), and those stocks went up a lot, before going down a lot. Mr. Hwang made enormous, levered bets on risky stocks, and those bets worked out perfectly; made him immensely wealthy in the course of a year or two, while he seems to have ploughed every cent of it back into increasing those levered bets.”
Money Stuff then succinctly states: “There is a simple schematic trade here:
1.Start with a lot of money.
2.Borrow a lot more money.
3.Use all that money to buy a ton of a small handful of stocks, cornering the market in those stocks and pushing up their prices.
4.As their prices go up, you have more equity – your positions automatically deleverage.
5.You use that equity to borrow even more money and plough it back into those stocks, pushing them up more.
6.Repeat for ever?”
Actually, for ever only lasted until the value of these stocks retreated (for whatever reason), capital markets being unpredictable. Margin accounts are used to borrow against a set-at-the time-of-borrowing value of a security. If the value drops, additional cash or securities must cover or replenish balances. As it appeared that Archegos was unable to raise additional capital, Archegos’ brokers issued margin calls, then liquidated massive Archegos stock positions, roiling markets.
“Only the rich can play this game”, said one headline. Apologies, Moneywise was unable to locate actual attribution of this quote. Some brokers and Archegos lost bigly, while one can only speculate what the collateral damage may have been to the millions of other stockholders of these securities.
Slate was even more specific. “Moneybox: The Dumbest Financial Story of 2021. Everyone involved in the swift fall of Archegos Capital Management should be embarrassed”, by Alex Kirshner, March 30, 2021. HTTPS://TINYURL.COM/2MEX28WB
There, you have it. Money madness, fascinating.
“Archegos Appeared, Then Vanished, Also the long-awaited GameStop ATM, and more……” Money Stuff, Matt Levine, Bloomberg, April 5, 2021 This is a terrific daily newsletter written in plain terms, and interesting, https://tinyurl.com/jbwhjxyn
Investopedia: An introduction to CFDs – Contract-For-Differences
“Leveraged Blowout: How Hwang’s Archegos Blindsided Global Banks,” Bloomberg Markets, by Erik Schatzker, Sridhar Natarajan, and Sonali Basak, April 1, 2021, https://tinyurl.com/t752pk6t
Step 17 of Book One of the Bermuda Islander Financial Planning Primer, Your Bermuda Financial Review Checklist for our unique Bermuda financial environment is now featured on RG’s website. https://www.royalgazette.com/bermuda-islander/
• Martha Harris Myron, CPA JSM, a native Bermudian, is the author of The Bermuda Islander Financial Planning Primers https://www.royalgazette.com/bermuda-islander/, international financial consultant to the Olderhood Group Bermuda, and financial columnist to The Royal Gazette, Bermuda. All Proceeds from these articles are donated to the Salvation Army, Bermuda. Contact: firstname.lastname@example.org