Comment by noname123 | Hacker News Reader

Comment by noname123 | Hacker News Reader

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Well, derivatives all have to somehow tie back to the underlying. Should be interesting to see the financial engineering on this.

Depends on the way they'll do this, one way is that they could approach some major stakeholders of Facebook (e.g., a pool of employees with vested or unvested employee stock options) and draw up some agreement with that entity to buy the rights to buy these stock options at a whole-sale strike price (let's say $0.05/share to buy the share at $75).Then the brokerage firms will chop these options to different strike price bins and re-distribute to investors (e.g., $0.15/share for the right to buy the share at $75, $10.15/share for the right to buy the share at $65; with the broker collecting a $0.10/share underwriting fees.).

So you are buying an option at a certain strike price to buy a potentially unvested option to buy a illiquid, pre-IPO stock at a certain strike price. If this was Google in 1999, someone is going to be rich. But since it is my opinion that Facebook is going to the way of AOL, I wouldn't buy into it; but then again, it depends on when Facebook is going to IPO and if it is before the Web 2.0 exuberance dies down.

If you read the Businessweek article he quotes from, the investors are buying shares in an entity that does nothing but own shares of facebook. Shares that they presumably bought on a private secondary market like the one detailed in http://www.avc.com/a_vc/2008/08/a-secondary-mar.html It sounds rather like a bucket shop to me, and those were made illegal for some fairly good reasons.

No Bucket Shops are where an entity says trades are going to take place and then doesn't execute them.

This is just a pretty standard private investment setup, that just happens to own a single stock.

Even if owning the single stock was a problem - and I don't think it is - working around it would be trivial. They could invest small amounts in a number of very low value stocks or in very stable stocks. Both those strategies would meet any hypothetical "diversification requirement" (which I don't think exists) without materially changing their exposure to Facebook.

Embarrassingly, I always though bucket shops meant something else. (I thought that this is what you call brokers with heavy flow that could cross much of their traffic internally without going to the exchange.)

I believe your definition is correct. My understanding is that the way bucket shops operate is that they are the customer's counterparty. So if you buy stock, they short it in equal amounts.

The business model, at least in the 1920's, was to get customers to take big positions on margin, then to manipulate the actual stock (on an actual exchange) to the point that customers were wiped out. If the manipulation cost less than what the customers put up, the bucket shop would win.

People occasionally accuse forex companies of doing something similar, but the market is probably too deep for any retail-facing forex company to successfully manipulate prices like this.

Reminisces of a Stock Market Operator talks about bucket shops--and trading against them--in detail.

> (I thought that this is what you call brokers with heavy flow that could cross much of their traffic internally without going to the exchange.)

What you describe here sounds like dark pools[1].

[1] http://en.wikipedia.org/wiki/Dark_pools_of_liquidity

I think they generally don't go to the exchange, but yeah, pretty similar.

That's pretty funny. If you'd said that was what it was I'd have believed it (it sounds right, and you worked in finance in NY didn't you?)

I did, but only at legitimate ones :)

...an entity that does nothing but own shares of facebook

You just described an index fund (albeit with only one stock in the index).

Bucket shops are nothing like this - bucket shops are casinos where the source of random numbers is the stock market, but no shares are ever traded.

is an index with just one underlying company actually possible?

I don't think so - we're not talking commodities here, but equity. Every index fund I've seen or traded had multiple underlying assets, even if some of them were derivatives...

BTW, stock market must be pretty bad random number generator...

Slightly off topic, but bucket shops are not dead.

Most, if not all of low end forex (at least the more honest ones spell it out in fine print) is basically a bucket shop.

You are buying(betting) against the house, that is all.

Also legal in the UK. Many retail investors use them, since they offer tax advantages.

http://www.tradefair.com/

they have to reference the underlying, but they don't have to involve delivery of the underlying. E.g you could define an index based on the valuation of facebook as implied by recent stock trades, and trade the index value, like a CFD.

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