What next...

So the Fed FOMC announced the cut in Fed fund rate and discount date by 50 bps each, which the market was not expecting. The bold move earned a lot of praise for Mr Bernanke and his colleagues. CNBC said God bless the greatest central bank in the world. Sombody said the FOMC is Friend of Market Committee.

So where will all the roads lead the economy. Will the crisis calm down. Well only the time will tell if the crisis is going to sustain or its going to subside. But for the moment the inflation concerns in US economy are looking down as the numbers of CPI, PPI etc have been lower than expected. But, Bernanke and Paulson have said in their testimony that there is still significant risk to the economy esp to the housing sector. Former chairman Greenspan also said that the recession chances are still at significant levels at 1 in 3.

On the other hand BOE chief Mervyn King is being critised by every one for his U-turn when the bank came to the rescue of Northern Rock Plc. after saying earlier that it won't act to help any financial institution as it would create a moral hazard. Defending his role in front og House of Commons Treasury Committee he said he would have prefered a covert help to the bank, but the rules makes it illegal without letting the general public aware of this. The government has guaranteed the money deposits with the bank. The treasury committee is not looking much satisfied much with the testimony and has ordered an enquiry for the current market crisis and the bank's role in it.

Well, the FOMC action brought a wide smile for stock traders and the equity indices across the world are soaring since then . Our own Nifty and Sensex have seen huge rallies this week.

Bin Laden Trade

Quite unusual. Whats this Mr Laden doing in financial markets!!!

Ok! here is the story. The open interest in September 700 S&P puts reached 116,000 contracts. Now since the current levels of S&P 500 is around 1450-1500 this is deep in themoney contract and has very least probability. The seller of such an put option would benefit if there is a huge market crash of the order of 30-50% within next three-four weeks. The market gurus says such a crash is highly uncertain unless there is a terrorist attack of the 9/11 attack. Hence this is given the name Bin Laden Trade.

The estimates say the potential loss to the seller could be in billions if there is no crash in the market. Now such a large bet by anyone obviously creating panic in the market leading even to rumors of a terrorist attacks before 21st September.

So does that mean there is really going to be a crash??? Does that mean we all are going to die within next four weeks??? A popular theory doing the rounds and explaining the idea behind this is as follows:

Selling of such a contract is actually done to take money from the market, since credit is not readily available in the market. The theory says that such a deep in the money contract trades on very high premium because the probability of happening that is very low. Now suppose a put contract which in 1000 deep in money would fetch the seller an approximately premium of 900. Now for the seller this is like a loan from the market. Assuming the normal condition when market stays where it is, the seller will loose the bet at the expiry of contract and may have to give the buyer an amount 1000 or so. This difference of 100 can be considered as the interest paid for the earlier loan of 900. This sounds too logical for such an occurance.

Will Fed... Won't Fed...

Thats the question participants of financial markets are confused with. The possibility of Fed cutting its target Fed funds rate emerged after Fed unexpectedly slashed down its discount window rates by 50 bps a couple of weeks back. The Fed's FOMC will meet in two weeks time to decide on its new monetary policy.

As per market enthusiasts the reduction is quite certain, as is evident from Fed funds futures prices which have taken into account a full 25 bps cut by september and a 75 bps cut by Dec'07.

However it seems that Fed's Bernanke is in no hurry to act. Last week he had told reporters that he will take every possible measure to calm down the credit crunch situation in markets. the current market turmoil has even forced Presidtn Bush to come up with certain policy changes to extend help to troubled homeowners.

In crude sector the focus seems to be now on Storm Felix after Storm Dean had missed key refinery locations in Gulf of Mexico in US coast. Though Met department has already predicted that the storm is set to miss US refineries in the gulf of Mexico, still crude futures were seen to be puuting up some gain.