If God is dead...

EaaS offered up a link to an interesting video that makes two claims. The first that put options are insurance and the second that selling such insurance on your own product is fraud. Maybe. The first time I've considered the notion is right here as I type this.

One of the great difficulties for folks looking into the financial sector from the barren weeds in the outfield is that the language spoken between the pitcher and catcher isn't simply a bit of reasonable jargon. It's what you get if you leave mechanical engineers in a strip-joint too long. You get things like double-reverse-Bangkok-side-straddles and other such nonsense.

You might think I'm being tongue in cheek, but it's long and valued tradition in the financial world to try to sell someone on an old scam with new terms. That's perhaps unfair as it's a long standing tradition of sales-wonks. But in the financial world this tradition is indeed settled and centered on the notion that you put your mark's peepers about three foot low and three foot back from a randy girl doing gymnastics on a chromed piece of pipe. That's how it is.

As for options there's very little interesting about them as can be seen if you put in them in a normal business context. IF you make a contract with a business to lock-in a future unit price on their product then you've engaged in a call option. In the future, if their product price is more than your guarantee then you have the leverage via the contract to force the price agreed upon. However, if the unit price of the product is less than what you'd contracted to then it's highly likely you'll forget all about the contract and take the better price offered.

A put option is the same thing from the other side of the trade. Rather than the purchaser you're the seller. And such a contract gives you the ability to force the purchaser to pick up your product at a price agreed to by contract. Admittedly it looks a little odd at first blush, but for a corn farmer this is the normal course of things when dealing with purchasers looking to lock in production and exclusivity from their suppliers, the good folks of Iowa.

In the financial world we just head on down to the local skin-joint and apply the same concept to options as to everything else: That it's directly tradeable and has a market value. This is the single key difference between the financial world and most sensibilities. No item belongs to anyone but the current bearer of it. And everything can be traded.

It's a singular difference and a reasonable one for anyone who agrees or disagrees. Normal folk far from the gilt halls of finance consider a contract to be between the individuals that were party to that contract. Only. Financial folk consider the contract to be an open-ended bit between whichever random parties happen to have possession on one side and the stern looking policeman forcing the other side to take responsibility for it.

There's a legal principle that a contract is a meeting of the minds. That it cannot be valid unless both parties gain something by it through the compromise. It's a bit gauzy as a notion but it's a storied concept in Western legal traditions. In extrema this means that no contract is tradeable as a market good as it only applies to the signatories of the contract. If that's your sense of it then most financials are fraudulent on their face. They purport to be contracts with no signatories.

It's only when we start carving exceptions into judicial practice that it gets a bit messy. There being so many current exceptions to things that it's best only to say that it's not a valid contract unless it makes direct reference -- in the letterhead -- to the particular case law being used as guidance for the ability to settle the matter in court. Written law doesn't apply here, natch. Jurists having long ago given up any pretense at their abilities to reading comprehension.

But can you consider options to be insurance? Why not, I consider keeping around two 9/16 box wrenches insurance also. But that's risk management, a hedge, rather than an insurance policy. An insurance policy is based on the notion of paying someone else a premium for a contract that states that they will make you whole to face or replacement value should an object be lost or damaged inadvertently. It is correct to state that you can use options as a risk management metric -- a hedge -- but it is incorrect to state that someone will reimburse you par value of the bond for holding an option contract against the bond.

It is distinctly different. Though should I sell you an options contract while purporting it to be an insurance policy? That's absolutely fraud. If I told you bearer options contract was invalid historically, that would be fine. If I told you that we ought hold it the same today, then that's fine also. However, if I told you that courts wouldn't honor options contracts then that would be fraud also -- if I were trying to sell you something else.

As a particular matter I don't see options contracts as being valid despite that the only money I've made in the markets is by playing them. But that's a matter for the electoral polls as the courts most certainly will honor them. However they are not insurance policies either, and it is incorrect to call them such. They are simply bets indistinct from internet poker despite being treated in a far different manner under inked law and by the bathrobe set with their toy hammers.

Now one can certainly claim that it's still illegal for the Federal Reserve to buy and sell options against US Treasuries. And that's certainly correct by the ink on the page regarding the creation and operation of the Fed Res. But then we're all far beyond the quaint notion of a neighborhood tough that it's only illegal if you get caught. It'd be nice if we were only beyond that into the notion that it's only illegal if you get convicted. But for that we have to see someone be charged first; and that ain't gonna happen.

But is it generally fraud to offer to buy back your own debt at a discounted premium? I can't see why it would be unless you maintain that you should only be in debt if you must be. Rather than utilizing debt as an option to avoid emptying the kitty in one go. The entire notion, sans the tradeable contracts, underlies the notion of short sales in the real estate market. And certainly, there's nothing fraudulent about a debtor forgiving a portion of their debt. Which is precisely what happens when we're discussing put option contracts as in the video; the whole notion is just done in advance at predetermined levels.

So options are not insurance despite that hedging your bets -- betting against your own bets -- shares some similar features. Nor is it fraud to offer to buy back your debt at a discount; even if it is a bit unsavory to sell potential future debt forgiveness at a profit to your creditor. It most certainly is a violation of the Federal Reserve Act despite that no one will ever cross such a high hurdle as to have a tense conversation with anyone from the Department of Justice.

But the only real question is whether the Federal Reserve is allowed to announce the price they will pay for US Treasuries. Let's say the Fed Res didn't actually sell the put options. Instead they just published that they would buy a certain number of US Treasuries at a given price. That would be perfectly legal and, if you accept the existence of the Fed Res in the first place, morally fine as well. Functionally, it's not far different from how they buy the blasted things in the first place; despite that their a bit more coy about the price they will pay.

But that makes the video's remaining notion out to be that it is illegal for the Fed Res to announce that it is willing to buy the only thing it is legally allowed to purchase. Not the fellow's point, but it's all that remains. Options contracts are legal whether they should be or not. In either case it doesn't rise to the level of fraud to sell them, even against the debt you owe. (Though it's technically the Fed Res selling purchase options against the debt you == personally -- owe. With all due gratitude of those that receive your Congress(wo)an's graft, natch.) This all despite that it's clearly a violation of law that will never see conviction since charges will never be brought.

TLDR: So there's the end of that stream of consciousness. And far too much seriousness paid to the wrong problems. After all, it doesn't matter which laws would be theoretically violated when it's plainly clear that we have no laws at all. So if you're at all concerned about such things it is worth reminding Eric Holder of this while you're anally raping him with a framing hammer in some dark D.C. alley. After all, that's only illegal on paper also.