Well I haven't intentionally been neglecting my blog but I do have some material that I have accumulated since my last post.
What-a-Waste
First of all I would share with you an article from the Spring 2007 edition of the MIT Sloan Management Review, Gloor and Coopers, The New Principles of a Swarm Business. This is most probably one of the most important papers I will read this year and importantly an absolute landmark model of operation and execution for our very own Greentoob. You can obtain a copy of the paper here: http://sloanreview.mit.edu/wsj/insight/pdfs/48312.pdf (When I read this article I was reminded of Jack Welch's comment about competing in China in his Business Week podcast).
Next, I would like to acknowledge some information sent to me by Kristin. Her first piece of Greentoob intelligence is a newsletter from www.recycline.com about Robert Redford's "green" show on the Sundance channel. I haven't caught the show yet but this is invaluable information as Greentoob begins to take shape. Its very much like being in a pitch dark room and trying to find out just what it is that is in the room with you. Kristin's second piece of Greentoob intelligence concerns the UK's Green Directory, www.greendirectoryshop.co.uk
"The Green Directory is the UK's most comprehensive listing guide to green living. As well as being the UK's only national directory it is the only directory to also include Regional listings - helping you to find organisations close to home".
(Talking of which, how dare my local telephone company send me three massive Yellow Pages directories - completely unsolicited. Who uses the Yellow Pages any more anyway? I'm not even a local phone company subscriber. So I would like to award the first ever Greentoob 'What a Waste' award to this particular organization).
Financial Weapons of Mass Destruction
Next up is a paper I wrote that I would like to share for comments. This paper really signifies the moment when I understood just what the risk is that obfuscated Private Equity poses to us all. In no ways am I trying to be a harbinger of gloom - just reporting what I found out. And as Black-Scholes states, "the option is implicitly priced if the stock is traded".
Introduction
There are two basic types of options: call options and put options. A call option allows its holder the right to buy a specified amount of the underlying asset during some period in the future at a predetermined price. A put option gives the holder the right to sell a specified amount of the underlying asset (Levy, p650).
Options are types of financial instruments that are classed as derivatives; value is derived from the underlying asset’s value rather than trade or exchange of the asset itself. Types of derivatives include futures, forwards, options and swaps. The main use of derivatives is to either remove risk – hedging, or take on risk, speculating.
An investor who is hedging wants to minimise the risk of financial loss from holding an asset when and if the price changes. For example, an investor who owns an asset such as portfolio of stocks wants the value of that asset to increase. The investor wants to limit, if possible, any loss in value. Therefore, the investor use the markets to take a position that can minimise the risk of financial loss from holding those assets when and if their price changes.
The speculator does not own the underlying asset. The speculator buys a call option, or sells a put option, hoping to profit from rising prices, while selling a call option, or buying a put option, hoping to profit from declining prices.
Discussion
Because of the sophistication of derivative trading, individual investors are typically warned to steer clear of derivative investing because of its complexity and risk. (For example, there are issues with the standardisation of trades). To demonstrate how a call option would be of benefit to individual investor I modified an example provided by Investopedia:
A speculator negotiates the option to purchase a house for $200,000 in three months time - a call option is created with a strike price. The right to do this costs the speculator $3,000, the premium. It’s discovered that the market value of the house is $1 million. Because the investor sold the speculator the option to purchase the asset, the investor is obligated to sell the house for the agreed $200,000 . The speculator is now “in the money”. An inspection of the house reveals the house is uninhabitable and the investment is now worthless. Because the speculator bought an option, there was no obligation to go through with the sale and the option is allowed to expire. The speculator forfeits the price of the option, $3,000.
Whether it is to hedge the risk of foreign-exchange transactions or to give employees ownership in the form of stock options, most multi-nationals today use options in some form or another. Despite an initial reluctance to use derivatives by institutional investors, now a variety of derivative instruments are used to hedge corporate activity. For example, in 2006 Hewlett Packard used derivate trading to hedge against its stock being diluted. The company’s stock price had increased 30% which prompted stock-options holders to trade their outstanding options. This sell off threatened to dilute the value of HP shares. To avoid this, HP entered into an agreement with BNP Paribas, for a fee to HP of $1.7 billion, whereby BNP would use an options collar of selling put options and buying call options with different strike prices to purchase HP stock and return the shares back to HP. This was achieved with a market price that was under the average listed market price of $38 for an HP share. HP had funded BNP to spread the repurchase of its share with different options on strike prices, spreading the risk of price fluctuation over a period of time. BNP bore the risk of price protection for HP by managing the risk between buying call options – a rising stock price - and selling put options – a falling stock price. BNP succeeded by managing the risk of trading in the space in between a rising and falling stock price. (My research could not establish whether European or American call options were used. The American call option allows the holder to exercise the option at any time during the life of the option. The European call allows the holder to exercise the option only on the option expiration date). ICI was one of the first companies that leveraged derivative trading when it purchased put options in the FTSE100 and call options in the fixed-income market to increase the performance of its pension fund in the early 1990s (Global Finance, Internet accessed June 3, 2007).
Conclusion
Trading commodity futures and options is not for everyone. It is a volatile, complex, and risky business. In 2003 Warren Buffett, in his annual letter to Berkshire-Hathaway investors, called derivatives, “financial weapons of mass destruction” [ http://www.berkshirehathaway.com/2003ar/impnote03.html ]. Buffet points to the Enron collapse, a company which relied on derivatives for most of its deals. To this end, Buffet closed down the derivative trading component of the re-insurance company that he had purchased, General Re Securities. In the US, the FBI acknowledge that stock options account for one-eight of FBI’s fraudulent caseload largely before the implementation of the Sarbanes-Oxley regulation. While the sophistication of derivative trading is typically beyond the means of the lay investor, for corporate institutions, the advantages of derivative trading are being promoted as a way to hedge corporate activity.
References
Levy H, Post T; 2005, Investments 3rd Ed., Pearson Education Limited, Prentice Hall
Commodity Futures Trading Commission, What you should know before you trade [Source]
[ http://www.cftc.gov/opa/brochures/opafutures.htm ]
Investopedia.com Options Basics [Source]
[ http://www.investopedia.com/university/options/option.asp ]
March 2007, Trading Derivatives, Global Finance, p52 – p54. [Internet] Accessed June 3, 2007
4 March, 2003 Buffett Warns On Investment 'Time Bomb'
[ http://news.bbc.co.uk/1/hi/business/2817995.stm ]
Beehive Co-ops
Finally ...
I came across a seemingly interesting company here in Atlanta, www.beehiveco-op.com.
Their mission, "is to nurture the creativity and entrepreneurial spirit of emerging designers and provide them with new markets and opportunities for their products". To facilitate this, their goal is to become, "a network of innovative stores all featuring and promoting local emerging designers". Best of luck to them I say and I'm looking forward to visiting the Atlanta location soon.
So I hope all this information does go to prove that I have in fact haven't been sitting on my Greentoob laurels and that I have indeed been thinking about just how big that elephant really might be. More developments soon I hope.
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