Here’s a rather scary — and under-reported — aspect of the recent sell off: Derivatives activity linked to share falls
"The recent sharp falls in stock markets appear to have been exacerbated by an unusual wave of derivatives activity on the part of hedge funds and big banks, traders yesterday indicated.
In particular, some banks and big investors appear to have been forced into selling large amounts of equity futures because they have been acting as counter-parties to large, leveraged bets on the direction of stock market volatility in recent months – and these bets are now unravelling because volatility has increased sharply.
This forced selling has hurt equity futures index prices on markets such as the London International Futures Exchange – and depressed the value of cash equities as well, some observers suggest."
Whenever I am asked how on Earth Dow 6,800 is remotely possible, I give to answers:
a) Forced selling leads to irrational market levels;
2. Nasdaq 1,100 was similarly unthinkable;
Derivatives activity linked to share falls
Financial Times, May 19 2006 03:00