War, and war’s alarms

Terrorists seek first of all to terrorize, to shock, to spread fear. To obtain recognition for their grievances by attracting the worldwide media, to destabilize the institutions of government, to establish itself among the local populace by demonstrating the ineffectiveness of government security forces, who in turn come to be seen as oppressors for ratcheting up security sweeps.

In Iraq, al Qaeda has not lost its capacity to kill. A brutal al Qaeda attack against the Yazidis in northern Iraq killed almost 500, a brutal outlier in a month where overall civilian casualties were down sharply. But the terror group can no longer shock us, the lidless eye of the media acknowledges the latest atrocity and then moves on, no longer impressed: The attack in the north was no more than a blip on the international radar – the world has grown altogether too accustomed to acts of shocking violence in that tortured land.

The central government remains ineffective but coalition forces sturdily prevent the terror masters from extending and consolidating their austere gains, for now. The local security forces gain strength and experience even as sectarian elements are purged, while in the Sunni west the tribes have come to understand the kind of alternative a Qaedist regime represents and have taken arms against it. Driven from the west by smart Marine officers, hunted out of the Baghdad belt cities by surged army forces, captured and killed in their thousands everywhere the jihadis are under pressure in Iraq, fast running out of allies, maneuver space and prospective recruits. Some of them are probably squirting out.

Against this backdrop, the Petraeus report approaches. Political reaction to the report will shape the policy debate in this country on the way forward for – or out of – Iraq. Terror cells have been turned up yesterday in Denmark, and today in Germany:

German authorities said Wednesday that they had disrupted an “imminent” plot to bomb American targets in Germany, possibly including the largest U.S. air base in Europe and Frankfurt’s international airport.

Three men in their 20s were in custody after their arrest Tuesday afternoon in a remote village in western Germany, about 100 miles north of Frankfurt. Police said they recovered large quantities of chemicals for making explosives…

German investigators said the suspects had obtained 12 barrels of hydrogen peroxide, a common ingredient in homemade bombs.

“This would have enabled them to make bombs with more explosive power than the ones used in the London and Madrid bombings,” said Joerg Ziercke, chief of the German federal police. He added: “This group distinguishes itself through its profound hatred of U.S. citizens.”

And separately, I received disturbing correspondence about possible market manipulation – similar to that which occurred prior to 9/11 – from someone in a position to know:

I hope you understand what selling short means. If you don’t, here’s a quick primer. When you buy a stock (or any investment) it means you are “long” the position. You hope to sell it at a higher price. The opposite side is called “short,” and it means that you sell the investment in the hope that the price will drop, and you can buy it back later at a lower price. The other way to do this is by buying option contracts. If you buy a “call” you are bullish, and if you buy a “put” you are bearish. Options can be bought for individual stocks or for the market as a whole.

It came to light after the fact, but prior to 9/11 there was quite a bit of short selling of both American Airlines and United Airlines common stock, as well as for Morgan Stanley and Merrill Lynch. Basically, the two companies whose planes were used in the attack, as well as a couple of financial firms who would be hurt by an economic downturn. After 9/11, activity was monitored to see if any more unusual activity could be found. As a side note, there’s a school of thought that al qaida did the short sales in order to profit from the attack, and acquire funds for future attacks.

Lately, there has been quite a bit of activity in the purchase of S&P 500 put options. Specifically, about $1 billion worth of puts have been bought, which is a pretty sizable sum of money. By itself, that’s not so bad. It’s just that these options were bought for a 50% decline in the S&P, and are scheduled to expire the third Friday in September.

A few caveats here. I don’t know whether the $1 billion was invested by just a few people, or across a broad spectrum of investors. Given the size of the financial markets, maybe $1 billion isn’t that much (Everett Dirksen?). Just the same, a $1 billion bet has been placed that the s&p 500 will have a 50% decline within the next three weeks. I won’t speculate as to who might have the ability to invest this much, but I can make a scientific… guess.

In performing due diligence I came across a seemingly plausible explanation which disputes the notion of “bin Laden” trades, saying this is a “box spread” option play:

As if the mortgage-market meltdown wasn’t enough to spook investors, some market players expressed concerns about unusual options bets that some observers have dubbed “Bin Laden Trades.”

The blogosphere and options trading desks have been rife with speculation about these trades, which are unusually large bets that the market will make a huge move in the next month. Some entity, or entities, has taken a large position on extremely deep in the money S&P 500 options, both puts and calls, that won’t pay off unless the market undergoes an extremely large price move between now and the options’ expiration on Sept. 21.

However, Dan Perper, a Partner at Peak 6, one of the largest option market makers and proprietary trading firms, has confirmed that the trades are part of a “box-spread trade.”

“This was done as a package in which the box spread was used [as a] means of alternative financing at more attractive interest rates” explained Perper.

Simply put, two parties agree to trade the box at a price that essentially splits the difference between current rates.

I’m a mutual fund guy, and options have always been beyond my personal risk tolerance, even when I understood them. “Box spreads” are utterly beyond me.

But I do know this: This isn’t over yet, not by a long shot. Best to keep our eyes sharp and our powder dry.

Update: The Allahpundit also connects the dots.