What happens when you combine oil money with Goldman Sachs? Well in Libya’s case you get a 98% loss according to the WSJ article:
There are very important lessons here for order flow traders. Pay attention here we go.
Libya’s sovereign wealth fund invested in financial instruments it knew very little about. According to the article they paid $1.3 Billion for some long dated call options during the first six months of 2008. That is a huge position when you pay over a billion for some options. Now they bought it on a basket of stocks with a lot of exposure to banks. No one places such a large trade based off of technical indicators or chart patterns, or trading robots, or quantitative analysis. This was a pure global macro bet on their part.
What were they betting on? Well if you buy call options especially on bank stocks you are hoping for stock prices to continue going up. That usually means stronger economy strong employment, strong GDP, etc. When you buy emerging market currencies that is also a bet on a strong global economy. They certainly were not expecting the financial crisis to come in full swing later on in the year. Once the financial crisis came and subprime housing collapse was in full swing the stock market and emerging market currencies fell dramatically. Their long dated call option value became nearly worthless since the stocks and emerging market currencies fell so much.
You may ask why didn’t they know the financial crisis was going to come? That is because at that moment in time during early 2008 there was still disagreement over whether the sub prime housing mess was going to spill over into the broader economy. The stock market made new highs back in fall of 2007, so from the aspect of the Libya sovereign wealth fund, the drop was a buying opportunity. They thought they were going to buy a dip in the market. Instead of buying directional exposure by going long the stocks and currencies, they chose the option route.
Anyways their global macro analysis came out to be wrong as stocks and emerging market currencies collapsed later on in 2008.
What is the lesson here? Well don’t trade in something you have no idea about. They should of had a better global macro analysis.
What is the other lesson? Well think about who was on the other side of that $1.3 Billion trade. It could of been Goldman selling them those call options, or some other institution. Bottom line is someone got a fat commission off that transaction, as well as someone pocketed over a Billion dollars in option premiums. One person loses, someone else gains. Money transferred from Libya to the person who sold them those options. Zero sum game.
One person had the right global macro call, while the other person was wrong. One person wanted long exposure to global growth (Libya) while the seller of the call option wanted to be betting on a decline in global growth.
Always be on the right side of the order flow and liquidity.