Only three days ago I wrote about the hubris of trying to eliminate risk with clever hedging. Today we got the best possible example: a massively failed hedge from the world’s best bank.
JP Morgan Chase (JPM) announced yesterday that it has trading losses of $2B. The losses were sustained in its Central Investment Office in London. Apparently they had taken certain positions as hedges against other positions, and these hedges had cause losses.
Aside from the impact to the stock, which is down 9% today, the other impact could be to regulation. Jamie Dimon (JP Morgan’s CEO) has been a vocal critic of the Volcker Rule. The Volcker Rule seeks to prevent banks from speculating with their own money and, thereby, jeopardizing their customers deposits. Now that JP Morgan has suffered a huge loss in trading (indeed in hedges that are supposed to reduce risk) it will be hard to argue that the Volcker Rule is not effective.
I have no way of knowing if Black Scholes was used in JP Morgan’s hedging methodology, but this proves once again that there is not such thing as a risk-free trade.