A widowmaker trade is a trade which while appearing to make total sense, it somehow will defy gravity for a time vastly longer than is rational. Thus traders with perfectly reasonable basis are driven bankrupt or forced to take large losses while they wait for the market to finally make sense. Classic examples are those that shorted the US housing market in 2005 or the tech sector in 1998(or shorting Herbalife). It's often clear to those thinking rationally that something mad is occurring, but the sheer time taken for the market to turn can make even the most reasonable investors lose faith. They even make movies about it, one won an Oscar.
The collary of course is the reminder that the interest rate demanded on Japanese bonds has refused to disobey the government demand to stay low, despite traders licking their lips and imagining they are George Soros. Widowmakers might not turn, they might be the new normal(or at least normal for over a decade)
The widowmaker recently has been applied to the choice of some to short the Australian Banking system. The most practical way to do this in Australia is to buy Puts, which is effectively the same thing.
Both methods, shorting stock and buying puts (long Puts) come with a cost. Shorting means to borrow stock, often with a cost equivalent to a debt interest. Plus if the stock goes up the loss is theoretically unlimited until you close the position. Buying an option means paying a premium for an option, but eventually that option expires, making the trade worthless.
The Australian Banking system is fundamentally a "too big to fail" system. The policy that four Banks, ANZ, Commonwealth, NAB and Westpac shall never fail is called the Four Pillars. It's position as an official and unofficial policy varies over time. This puts these Banks at a distinct advantage over their competition. They will never go to zero while the policy holds.
But they may go to hell. The policy also acts to prevent(or at least limit) potential capital inflow from foreign sources in the event of major negative event.
The factor which leads to the banks weakening is simple, the Australian nation is leveraged to the hilt. Only the extremely low interest rates worldwide is saving the borrower's from their debt eating them alive. Even then, buying the Sydney median house will cost you $1021000, with 10% deposit will cost you $56492 in repayments over 30 years at a 4.59% interest rate(according to the NAB). I do not believe there is any realistic way down for interest rates. Even a RBA reduction in rates would only have a mild effect on cutting costs to borrowers. However any increase will have a growing effect. The argument that the RBA will never do this simply doesn't hold water.
The second argument is that capital inflows from Chinese investment andor money laundering will maintain prices. I believe this is having an effect, but nowhere near the popular Press theories. But I feel it has a limited capacity, based on the simple observation that the Chinese government are not as nationally corrupt as western governments. Unlike the West, if things are bad for the nation, the Chinese government will act. This makes them difficult for someone raised under a western government to predict them. A government which does sometimes act in the best interest of the nation is the definition of "Outside context problem". Eventually they will stop the outflows.
Continued in Part II
All commentary is general and is not financial advice.
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