'Puts' 'Calls' and other options

[RogerS]

Reading a book the other night which featured these, the thought came to me that if the financial authorities around the world banned these then perhaps we would start to get back on the straight and narrow.

Back to traditional banking...ie I have some spare cash which I deposit with the bank and get a reasonable rate of interest and the bank lends it to a business to expand and charges a little bit more.

Or is that too simple and easy?

 

[flanajb]

Too simple. Options were originally hedging instruments. If I have a portfolio of stock, I may want to purchase an option to hedge my position in case the share price falls, otherwise, your loses will be much greater. Think of it as an insurance policy if things go wrong. No different to taking out an extended warranty on that new TV you buy.

Where the system has gone wrong is allowing people to buy derivatives against financial instruments they don't own. This to me is like taking out an insurance policy against someone else crashing their car. That and short selling are morale wrong and caused a whole world of pain.

The trouble with you lending to the bank and them then lending your money to a business, means that the Banks will very quickly run out of cash to lend as the business will tie up the loan for a period of time. After a while the bank has no money to lend.

That is why they formulated asset backed securities so they could raise more capital based on the asset sitting on their balance sheet. The system does work fine, it is the speculation and greed that caused the system to fail.

 

[Jacob]

"Whoops" by John Lanchester is a very good read on this topic