Eurenergemic. Is that an SAT word? Derivatives. Isn’t that math for nerds?

If you’re willing to read all the way to the end, there’s a treat. Also, it’s Friday, so lots of fun today.

September 9, 2022

Notable

• European nations are setting up programs to give/loan money to both households and businesses to counter the high cost of energy. Numbers being tossed around: 170B GBP in UK, 65B EUR in Germany, $1.5T for liquidity for the energy market. Yes, you read that correctly. Trillion with a capital T. That’s for the derivatives market (traders) who might get margin calls.
• Europe can’t agree on a price cap for Russian gas.
• Markets break a 3-week losing streak

Commentary and fun

Eurenergemic (Look, I invented a word!)

European nations have threatened to put a cap on how much they’ll pay for Russian gas. As mentioned before, this is a lot of hot air since Russia would just sell them nothing and then they couldn’t make hot air while Winter is Coming. Following through on their threat would mean that the price of energy would go up even more. There also isn’t unanimity because though the entire EU economy is being hit hard, there are countries that are being penalized even though they DON’T need energy from Russia (Portugal, for example). Like the pandemic, this has become the Eurenergemic, and nations are certain to start giving out tons of handouts so people don’t lose their jobs, freeze, or starve to death.

Derivatives — You’ll understand why some of those financial guys either get filthy rich or commit suicide.

Above, I mentioned that there’s a chance that nations will need to put up $1.5T in order to provide liquidity for the European energy derivatives market. Derivatives? Huh? Read on! In fact, while impossible to know for sure, some estimates of the world-wide derivatives market top $200T. That’s like…all the markets we talked about yesterday added together.

Derivatives are options and futures. For simplicity’s sake, let’s forget about lots of complicated words like contango, backwardation, delta, vega, theta, gamma, rho…are we talking finance here or learning Greek? The easiest way to understand derivatives is as BETS with a LOT of leverage. What’s leverage? It’s when you multiply a bet your winnings (or losses) by 100 or 5,000 or 100,000 (Which can get really scary. Suicide!).

Maybe you think Apple will go up. You might buy an APPL call option (i.e., derivative or bet) that will pay you 100:1. Of course, you have to put some money down and if you’re wrong you lose it all. Or maybe you think the cost of soybeans will go up. You might transact a soybean futures contract (i.e., derivative or bet) that gives back 5000:1….or takes away 5000:1 (Suicide!).

Futures are more dangerous than options, but that’s complicated and it’s Friday so let’s pretend you don’t care and not go into detail even though you really really do care. Still, this should give you an idea as to why the derivatives market is so big. Leverage. And because it’s so big, it’s very very dangerous which is why it might take $1.5T to keep the energy market running to fight Putin — is that guy ever going away?

Btw, there are actually good reasons for the existence of futures contracts (besides gambling). Just ask a farmer.

The fun stuff. Finally!

Movies that you’ll understand better after this email.

Margin Call — Leverage!

Trading Places — Why does Eddie Murphy care about oranges?

The Big Short — CDO’s, MBS’s, AAA tranches…okay, nobody really understands this one but there are some amazing actors in it.

Wall Street — Actually, this is insider trading and private equity, but it’s still fun because, hey, Greed is Good.

Pretty Woman — Actually, this is also private equity, but hey, Julia Roberts!

That’s the wrap for the week. Enjoy your movies this weekend, and we’ll see you online.

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