[Scoundreller]

> I don't believe that LTCM was insuring anything.

While most of their strategy was convergence arbitrage, if I recall from the book, they thought of selling short equity options as a form of selling insurance.

People buy these options to insure against some event and they expected more buyers than sellers, so LTCM figured they would profitably be the provider of it. Well-structured insurance is always a loss to the buyer (they take in more than they pay out).

[wjnc]

Insurance works because people, companies, shareholders etc are risk-averse and thus value paying a little for reducing variance a lot. That’s not a loss to the buyer. NPV isn’t the only measure of value.

[edmundsauto]

Been a while since I read the book as well, but wasn’t part of the narrative that their backstop as insurance enabled traders to take bigger and bigger bets, because they were hedged with LTCM?

[seanhunter]

I don't think any trader at a broker/dealer would think that, but it's possible people on the buyside thought that. There are plenty of funds who have a strat of just allocating say 95% of their holdings to the Russell or something and then putting the remaining 5% into some high-vol bets (like putting them into LTCM or whatever). They don't see it as a hedge exactly, but it means that they hardly need to work at all and when these pay off they say "look this is alpha" and when they don't they say "look, your error vs the Russell is less than 5%". Some funds (eg big pensions) have enough AUM that this risky piece is a very significant amount of money.

I was working in the city shortly after LTCM failed and one of the interesting things I heard is that several large European institutions were using LTCM for overnight treasury. So at cob in Europe they would sweep funds into LTCM and then move them out the next morning for trading. If that was actually the case it would have caused massive fluctuations in their assets during the day which would be extremely hard to manage.

[djsavvy]

Which book are your referring to?

[400thecat]

When genius failed. there is no other book