What You Must Understand About Derivatives and Other Wall Street Creations
A friend of mine recently asked me what I thought of a derivative investment called "equity-linked reverse convertibles." Before I explain my answer, I want to tell you a story about something that happened to me when I was a cadet at West Point.
I was on leave in New York City when I happened upon some men playing a card game. There were only three cards; one was red and two were black. I later learned this game was called Three-Card Monte. One man, who we'll call the "operator," would expose all three cards, turn them over, and then quickly move them around. The objective was to identify the red card. With a minimum bet of $40, you wagered on where the red card ended up. If you correctly identified where the red card was, you doubled your money.
Another player, who we'll call the "mark" a.k.a victim, was dressed much better than the operator who was running the game, and was consistently losing his money. I watched for a while and found it easy to follow the red card. Of course, I was encouraged to play by the onlookers, but $40 was a lot of money to risk back then. Yet I kept watching the mark lose his bankroll, meanwhile, every time I knew exactly where the red card was.
Finally, the lure of easy money proved too great. I pulled out my wallet and plunked down my $40. And for the first time, I guessed wrong! Undeterred, I tried again and guessed wrong again. At this point I was ready to leave, but just then the mark grabbed me by the shoulders. "Hey, let's not let this guy beat us out of our money!" he said, as he implored me to keep playing.
I reached into my wallet and pulled out my last $20. I didn't have enough for a full bet, but they let me slide. I was going to lose anyway. And so $100 dollars lighter, I found a pay phone and called my dad to get him to wire money to Western Union so I could buy a bus ticket back to the Academy.
On the ride home I realized I had been tricked. The supposed "mark" who kept losing his money was not a mark at all. He was actually a shill or a person who encourages others to play a gambling game and a confederate of the operator who ran the game. My initial perception had been entirely wrong. **I** was the mark or sucker.
In retrospect, I could have evaluated the situation differently. Obviously, the fellow running the game was no fool. The game was his livelihood, and he knew what he was doing. It was foolish of me to think I could beat him at his own game.
...Which brings me back to my friend who asked me about the equity-linked reverse convertible. Remember, whenever Wall Street creates a complicated product that's difficult to understand, it's extremely unlikely that ordinary investors are getting the best end of the deal. After all, the people who create these products are highly sophisticated and the game is their livelihood. In "Wall Street Monte," they know how to play the role of the operator.
I told my friend to pass on the equity-linked reverse convertibles. Stick to transparent rules and keep your investment decision-making simple. By using what I call "naked investing" - meaning you know the rules just like everyone else - then you can avoid the bad market odds that come with many of Wall Street's trumped-up creations.
By entering you email address in the window on the upper right hand side of this page, you can subscribe to this blog for free and be notified each time a new entry posts.
I was on leave in New York City when I happened upon some men playing a card game. There were only three cards; one was red and two were black. I later learned this game was called Three-Card Monte. One man, who we'll call the "operator," would expose all three cards, turn them over, and then quickly move them around. The objective was to identify the red card. With a minimum bet of $40, you wagered on where the red card ended up. If you correctly identified where the red card was, you doubled your money.
Another player, who we'll call the "mark" a.k.a victim, was dressed much better than the operator who was running the game, and was consistently losing his money. I watched for a while and found it easy to follow the red card. Of course, I was encouraged to play by the onlookers, but $40 was a lot of money to risk back then. Yet I kept watching the mark lose his bankroll, meanwhile, every time I knew exactly where the red card was.
Finally, the lure of easy money proved too great. I pulled out my wallet and plunked down my $40. And for the first time, I guessed wrong! Undeterred, I tried again and guessed wrong again. At this point I was ready to leave, but just then the mark grabbed me by the shoulders. "Hey, let's not let this guy beat us out of our money!" he said, as he implored me to keep playing.
I reached into my wallet and pulled out my last $20. I didn't have enough for a full bet, but they let me slide. I was going to lose anyway. And so $100 dollars lighter, I found a pay phone and called my dad to get him to wire money to Western Union so I could buy a bus ticket back to the Academy.
On the ride home I realized I had been tricked. The supposed "mark" who kept losing his money was not a mark at all. He was actually a shill or a person who encourages others to play a gambling game and a confederate of the operator who ran the game. My initial perception had been entirely wrong. **I** was the mark or sucker.
In retrospect, I could have evaluated the situation differently. Obviously, the fellow running the game was no fool. The game was his livelihood, and he knew what he was doing. It was foolish of me to think I could beat him at his own game.
...Which brings me back to my friend who asked me about the equity-linked reverse convertible. Remember, whenever Wall Street creates a complicated product that's difficult to understand, it's extremely unlikely that ordinary investors are getting the best end of the deal. After all, the people who create these products are highly sophisticated and the game is their livelihood. In "Wall Street Monte," they know how to play the role of the operator.
I told my friend to pass on the equity-linked reverse convertibles. Stick to transparent rules and keep your investment decision-making simple. By using what I call "naked investing" - meaning you know the rules just like everyone else - then you can avoid the bad market odds that come with many of Wall Street's trumped-up creations.
By entering you email address in the window on the upper right hand side of this page, you can subscribe to this blog for free and be notified each time a new entry posts.
0 Comments:
Post a Comment
<< Home