Recall the scene in the 1983 movie Trading Places in which Dan Aykroyd says out loud upon awakening, "Pork bellies." No further introduction is needed; the viewer is cued that Louis Winthorpe III intends to spend a good portion of the day dealing mischief in the quintessential bare-knuckle trading instrument of that era.
Would a remake of this movie today require a far different character, most likely one without Roman numerals behind his name, to awaken and proclaim to no one in particular, "Swaptions on credit default swaps?" It might be an appropriate update, but I would be willing to wager very few would understand what exactly was to be traded. A CDS swaption gives the holder the right to buy or sell credit protection at a given strike or price, and let's just limit the description to that.
This thought and others crossed my mind last week while chairing a Marcus Evans conference in New York called "Investing & Trading in Volatility." That we are viewing volatility as a separate market in and of itself is unremarkable; the history of financial markets over the past three decades has been a continuous progression away from trading tangible instruments, such as stocks and bonds, to all manner of increasingly exotic derivatives based on increasingly conceptual underlying assets and concepts. Indeed, much of what was considered exotic only five years ago is considered vanilla today.
Many of these markets exist only in the world of large investment banks and hedge funds. What they do to each other behind closed doors is their business, and for the most part, you and I can go about our daily affairs unmolested while they trade some vapor like CDS swaptions with each other. But there are some things that may affect the real world.
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