“Convexity Is Always Lurking” – Here’s How Credit Suisse Managed To Lose $4.7 Billion In The Archegos Debacle
The (hopefully) last shoe dropped on the collapse of the Archegos Hedge Fund with Credit Suisse closing out (?) their positions in VIAC, VIP and FTCH yesterday.
So how did they manage to lose of $4.7bn…?
Here is my back-of-the-envelope guess:
Brokers are usually restricted to lending only 50% of a security’s value; so with a VIAC close on March 22 at $100.34, they could lend $50.17, or be at risk if VIAC dipped below $50.17 before they could collect a margin call.
Rumor is that some firms were using swaps to offer 5 to 1 leverage, which is the equivalent of lending 80% vs a margin deposited of 20%.
Using this math, the client posted $20.07 and the broker lent $80.27, which means that the broker was on the hook below $80.27 until they could collect on a margin call.
For risk purposes, this can be replicated as the broker being short the $80 strike put with a one week expiry (the time to satisfy a margin call).
This option was worth about 15c on March 22; BUT…that assumes one can trade 34mm shares (~7% of the float) in a single trade.
The more realistic risk replication is a one to two month option (think Lehman Brothers) so the “short option” can be modeled at about $5.
Consequently, the broker is effectively short a VIAC put option on 34mm shares with a strike of $80. If they closed out the ticket at ~$42/share (an option price of $80 – $42 = $38), that would create a loss of $33 per option ($38 – $5).
34mm shares times $33 equals $1.122bn.
Repeat for the other positions, and there you have it.
It’s never different this time since short Convexity is always Lurking near the scene of the crime.
Read more here…
Tue, 04/06/2021 – 16:45