Mark to Make Believe

I have to share this gem from Barry Ritholtz:

"Thanks to the Congressionally mandated FASB rule changes back in March
of 2009, Mark-to-Market has been changed to Mark-to-Make-Believe.

We do
not know if these banks are actually profitable, whether they are barely
solvent (Chase/JPM), somewhat insolvent (BofA) or totally insolvent
(Citi)."

***

Barry believes the bonuses are based on 'massive fraud.'  The government gives money to the banks at 0% and then borrows that same cash by issuing bonds that pay 3%.  How difficult is it to make money when doing that?

I must agree.  Sure the bonuses make me angry, but the bonuses are not the major issue. It's that these banks were bailed out to contribute to the economy.  They were supposed to lend money to qualified borrowers and to help small business survive and prosper.

Why take that risk when the government hands them a free, 3% arbitrage opportunity?  This stinks.  And the new, proposed tax isn't good enough.

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4 Responses to Mark to Make Believe

  1. JV 01/15/2010 at 9:59 AM #

    Not sure how to post here but have a simple question.
    If short call goes ITM enough the purchaser will exercise it. In a spread situation is this the same on stock and index. if for example I short the RUT at 650, go long at 660 and index settles at say 657 on expiration can the buyer exercise this? Same with a stock like Apple or whatever. If the stock settles between my short and long at expiration could I be in jeopardy of having to supply the shares?

  2. Mark Wolfinger 01/15/2010 at 10:29 AM #

    Hi JV
    1) You posted correctly.
    2) The owner of a call option should almost NEVER exercise an option any earlier than necessary. And that’s when expiration arrives. But it does happen on occasion.
    There are exceptions (capturing a dividend), but for most purposes, you can ignore that.
    2) Yes, the option owner can exercise. there is no ‘can’ about it. He/she WILL exercise. In fact, these days, it’s done automatically.
    This has nothing to do with your other positions. It does not matter whether you bought of sold the RUT 660 calls – or any other option. The owner of the 650 call is going to exercise.
    3) I hope you know that RUT is a European style option and that means it settles in cash. In your example, $700 (the intrinsic value of the option, or the amount by which RUT settlement price exceeds the strike price) is removed from your account for each option you are short.
    That just means you are re-purchasing the option at it’s intrinsic value.
    No shares are involved.
    4) Stocks, such as AAPL do not settle in cash. They are American style options and settle in shares.
    If you do not buy back the calls (that are in the money) and are still short those calls by the time expiration arrives, then you will be assigned an exercise notice and must deliver the shares.
    If your long calls are also in the money, you simply exercise them and you have no worries (although the call spread that you sold has lost the maximum possible amount).
    If the call you own is out of the money, do not exercise it.
    You have a few alternatives:
    a) buy back the option you sold. End of problem. Best solution.
    b) do nothing. Your account will be short 100 shares of AAPL stock for each call option. This is a risky position and you probably do not want to do it, but it is an alternative. That is, if your account is allowed to be short shares. Not all investors have such accounts.
    c) buy shares to cover the short options. I don’t like this choice either, but it works.
    BUYING BACK THE OPTION is the best, quickest, simplest way out of this jam. Yes, you probably have a loss, but you already have that – and getting out of the current pickle is your first priority.

  3. Andy 01/16/2010 at 1:46 AM #

    thanks for pointing out this article. It seems to make sense and explains why the market did what it did after chase reported earnings on friday. I wonder, how can I comfortably invest when such volatile changes are happening?

  4. Mark Wolfinger 01/16/2010 at 10:14 AM #

    Them market move had nothing to do with this ‘news.’
    Comfort is individual. To me these markets are ultra calm and ultra stable. Apparently you have a different perspective.
    If uncomfortable, find a conservative play that meets your needs. It may be Treasury bills if you want no risk.