Bank of Volatility Summary and Analysis

Long-Term began to short the market in early 1998. The fund maintained its basic trading strategy and this is what would lead them to destruction. The "equity vol" was the signature Long-Term trade and was based on the consistency of volatility. Option prices rise when markets are jumpy. Knowing the option price allows one to estimate the amount of market volatility.

When Long-Term expected prices to fall, they began to short stock index options. Long-Term and other hedge funds felt that prices were too high, so they were selling insurance against the expected falling prices. Long-Term tailor made private options contracts for long-term options that don't trade on exchanges, which increased their risk. Five years is a long time and Long-Term began to make more risky trades as it bet on the US stock market declining. Scholes, Merton...