Yesterday, I mentioned future contracts could be used as a way to insure against risky commodity prices. This is one way that future contracts can be used. Unfortunately, future contracts and options can also be used to speculate on the stock market. Stock market options enable investors to take a position on the stock market rising or falling. If you expect the stock market to buy you can take out a contract to buy at a certain price. If the stock market rises you can then buy at the fixed price and immediately sell for the higher price. Options enable an investor to magnify his gains, but also can magnify his losses.
Many banks allow investment managers to have an element of discretion in taking ‘positions’ on the future of the stock market. If they get it right they can make money for the bank and probably earn bonuses. However, these positions can also lead to losses.
It quite often happens that a trader may make heavy losses, and so he (it’s nearly always male) uses more money to try and recover his losses. This can start a spiral of losing money and then borrowing more to try and recover losses.
Some traders can rack up huge amounts of debt and then cover their losses by using fictitious accounts. In certain cases these losses can spiral out of control.
A famous example is Nick Leeson who led to the collapse of Barings Banks.
It seems that the French Bank Societe Generale now has suffered even bigger losses. It appears one rogue trader has lost £3.5 bn on the stock Market. – There losses compounded by plummeting stock markets.
Stock Market losses at Guardian