Hedging Intelligence
“It is hard for us … to even see a scenario … that would see us losing one dollar in any of those transactions” - Joseph Cassano, president of AIG FP, August 2007.
AI FINANCIAL PRODUCTS.
The failure & bankruptcy of Lehman Brothers kicked off the financial crisis.
The next day, AIG (specifically, the subsidiary AIG Financial Products) almost took down the global financial system, with the last-minute US government bailout preventing the a total system collapse.
That AIG (an insurance company) was so exposed to Lehman Brothers - to the extent that AIG was going to be forced to file for bankruptcy the following day - caught the world by surprise.
Absent that bailout, a bigger surprise would have followed - a cascade of American bank failures, rolling into global bank failures (again, absent many more bailouts).
The culprit - AIG Financial Products - focused principally on OTC derivatives.
Earlier this summer, SharonAI (a NeoCloud customer of Nvidia) disclosed enough of their contract terms with Nvidia to work out the contract economics (SemiAnalysis has a very good note on that topic, if you’re curious).
Putting the contract economics aside, the backstop provided by Nvidia is an OTC derivative - one of many.
In options language, this specific trade is short skew, short the left tail, collecting participation carry...
… aka the payoff signature of an insurance underwriter.
And that sounds like AIG FP.
This trade is exposed to wrong-way risk - the put pays out precisely in the scenario where:
Nvidia’s core chip demand;
Its equity; and,
Its other backstops are all deteriorating, simultaneously.
Which, today, is … hard for us … to even see a scenario …
All that said - if I was Nvidia, I’d do the trade.
But I’d also press for the development of compute futures, and I’d do whatever I could to develop a robust third-party derivatives market.
The risk exposures from these transactions are both complex and - once a competitive derivatives market is developed - not strategic.
Technically, this Nvidia OTC derivative is a strip of physically-settled, volumetric put options on GPU rental revenue with declining strikes, premium received as fractional call participation at the same strikes - a vendor-written participating collar whose function is credit-wrapping merchant compute risk.
Also known as a mouthful…
…which the market hasn’t fully digested -
OTHER NEWS.
Warsh is a hard-read
ConocoPhillips change of guard
Hope y’all had a good weekend -