By Zach Scheidt
This post As the Dust Settles, WMD Evidence Mounts… appeared first on Daily Reckoning.
As the dust settles from Monday’s flash crash, we’re starting to get a better picture of what actually happened.
It turns out the carnage can be traced back to a kind of financial “weapon of mass destruction” — or WMD. Traders regularly use these instruments to siphon cash out of the market. But one wrong move, and BOOM! — as we saw firsthand earlier in the week.
So today, we’re going to shine the light on this dangerous weapon, and also look at what you can do to protect your wealth and profit from the fallout…
Warren Buffett Exposes “Lethal Danger”
The instruments I’m talking about are called derivatives. They’re simply side bets that investors and traders make on different market movements. While that might sound innocent, legendary investor Warren Buffett had scalding words about them:
“In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal”
Even though the “Oracle of Omaha” said this in 2002, the truth of his words still rings true today. Derivatives can be very dangerous when used incorrectly. Like the shockwave from a nuclear explosion, their effects can cause devastation over a widespread area.
Just look at how one class of these derivatives created a tsunami of selling across the entire global stock market.
Volatility Derivatives Trigger a Nuclear Reaction
It’s no secret that the market has been uncharacteristically quiet for the last several years. Heck, the S&P 500 hadn’t experienced a back-to-back daily drop of one percent or more for about two years. That’s unprecedented!
As is often the case, the Wall Street geniuses created an invention to bet on the market continuing to stay cool, calm and collected. The invention was “short volatility” strategies.
The terminology sounds complicated. But the idea is simple.
New futures contracts, option contracts and even ETFs that trade like stocks were introduced.
These inventions allowed investors to make long-term bets that the market action would be quiet. And as long as everything stayed under control, these investors would print money day after sweet and serene day.
For a while, it worked fine. But then came the storm.
Below is a chart of the CBOE Volatility Index (VIX) — often referred to as the “VIX” (pronounced “Vick’s”)
Volatility started to pick up when traders reacted to a minor uptick in inflation data. The inflation information itself wasn’t a big deal. But as a few traders started selling some shares, it triggered a chain reaction in these nuclear WMDs for the market.
Chain Reaction of Panic
The “peaceful and calm” bets have an interesting twist…
Essentially, the best way to offset a rise in volatility is to sell shares of stocks. (It’s a bit more complicated than that, but you get the general idea).
This week, as traders sold shares to offset their volatility risk, the market naturally fell lower. This caused more volatility, which naturally led to more market selling. The chain reaction fueled itself causing stocks to trade lower …read more
Source:: Daily Reckoning feed
The post As the Dust Settles, WMD Evidence Mounts… appeared first on Junior Mining Analyst.