Reduce naked risk

Jamie Whyte’s proposal for amending bankers’ pay structure [Strippers can show us bankers’ just rewards, yesterday] is certainly worth consideration but needs further refinement. In Whyte’s model the bank is still subject to losing large amounts of capital at the hands of its trader, whereas Stringfellow faces no such capital risk with his lap dancers.

A trader winning the auction can lose the bank millions and the higher the winning bid, the higher the risk of the trader taking a big losing bet – the risk/reward is still very asymmetric. The way to avoid this problem would be to control the trader’s bet by putting in place a stop-loss limit equivalent to the trader’s winning bid in the first trade.

If he makes a bad first trade, he is blown out, but the bank only loses the amount it gained in the auction. If the trade is successful then, say, 15 per cent of the profit would be added to the trader’s pot, together with the auction amount, and his subsequent trade could be protected by a stop-loss equivalent to the size of the pot. This could be repeated for further trades with the contents of the pot determining the stop-loss limit on any trade.

In this way, the bank’s capital is protected in the event of a losing trade and an adequate return is made by the bank on the capital at risk in any winning trade.

Zafar Khan
investment analyst