A Million Dollar Hedge!
Team Latte
May 3, 2005
A relatively obscure piece of news caught our eyes Today. An investor in Australia has sued Merrill Lynch Equities for more than $1 million. Moreover, the investor has apparently taken Supreme Court action, which is rather stunning and perhaps, implies the significance of this matter from the plaintiff's point of view.
Lowell Catalano, the plaintiff (see the report in The Age and Risk Latte News, Maybe section) has taken Supreme Court action and claimed that Merrill Lynch did not properly advise him of the high-risk nature of using a hedged equity investment loan (HEIL). The statement of claim described a HEIL transaction as buying shares in a company that was about to go ex dividend with a high yield, and simultaneously buying put options and selling call options "so as the total risk of profit and loss at the expiry of the options is known".
The details of the case is not that important but rather what is more important is the milieu in which this case is set. We are now moving into an age of great uncertainly. The bulls and bears are clamouring for the investor's ears but neither of them has a clue as to where the equity markets are headed. Hedge funds are becoming more un-hedged and straight equities are getting more hedged. Banks are hiring equity derivatives traders and sales professionals by the horde and the poaching game is at its zenith, once again. The belief that derivatives, tied to simple equity, can solve all ills and is a recipe for profits in all markets has never been so widely cherished as now. Or so it appears.
So what are these simple derivative strategies that the banks and brokerage houses are furiously peddling to the investors? What is a hedged equity investment loan? What is the magic elixir that will protect our wealth and make us sleep well at night? How can we sell a stock when the market goes down and not lose our shirt? The answers to these questions may seem trivial, simple and a breeze to the million dollar banker but perhaps, a Lowell Catalano may want to check out the following links so that next time he is well prepared for his million dollar loss.
  
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