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Thursday, July 22, 2010

Goldman Gets Hit By The Black Swan As It Shorts Volatility

Seems that in at least one case Goldman's clients were savvier than their market maker.Clients took on the equivalent of the black swan trade (that can be done with the volatility etns) apparently buying volatility directly from Goldman with over the counter derivatives. Instead of hedging Goldman apparently sat on the short volatility created by the client trades.

 From the WSJ: (my bold)

...When the financial markets are topsy-turvy, Goldman Sachs Group Inc. has a knack for finding a way to profit from the turbulence. That didn't happen in the second quarter.
Goldman reported an 82% profit tumble, hurt by a surprisingly steep decline in revenue that included a wrong-way bet on the stock market's volatility. The New York company didn't disclose the size of the loss, which occurred in its equity-derivatives business and is an unusually large blunder given Goldman's reputation for prudent risk management....
... the firm made a costly decision not to completely hedge bets made by customers that the market's volatility would rise during the second quarter. "We were directionally wrong," Mr. Viniar said.
Asked whether Goldman itself made a mistake in the firm's view of turbulence in the market, Mr. Viniar responded that Goldman "didn't hedge it fast enough."
One managing director on the stock-derivatives desk that is responsible for the losses recently left Goldman, and other employees in the unit are considering leaving, according to people familiar with the situation. The departed managing director was a salesman. Goldman declined to comment.
Earnings for Goldman Sachs slid 82% in the second quarter, socked by its settlement with the SEC and the U.K.'s payroll tax. Paul Vigna, Neal Lipschutz and Bob O'Brien discuss. Also, John Bussey discusses why the Senate is poised to extend unemployment benefits for 2.5 million Americans after three previous attempts failed to gain sufficient Senate support.
As a result of the losses, "the most striking shortfall on the revenue line was equities trading, 

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