Let’s say I was looking for someone to give me a bottle of 1982 Lafite or Petrus, and I would promise to return a bottle of identical quality (but not actually the same bottle) in, say, 10 years. Legal contract and everything. Would anyone be interested? How much money would I have to pay for the effective right to hold (but not drink) the wine for a decade?
You would be long the cheapest-to-deliver option. Another way of saying that the counterparty bears
the provenance risk.
The trick is assuring, “a bottle of identical quality (but not actually the same bottle)”.
Would you need a third-party to certify bottle condition and provenance on both ends of the trade?
That’s certainly right about provenance risk. I imagine I’d need to be lent a bottle that materialized on the secondary market with a mysterious past in order to be able to return a similar one…or something?
You could look at it as a repo. You give the other side the money in exchange for the wine and 10 years from now they give you the money and you give them the wine. Find out from Victor what his company has done with the 10 year T-Bill rate, add a risk premium, compound the interest rate, and come up with a number.
JayHack, that makes perfect sense, although I have no idea how to begin calculating the risk premium. Also, if I’m actually serious about this, does anyone have any idea if anyone out there in the wine world would actually do this transaction with me?
This sounds weird to me (granted, I’m not into “the market,” so am completely ignorant about these things). Dan, what do you stand to gain out of this deal? What does the other party stand to gain out of this deal?
And the owner would have a TON of counterparty exposure to you as well All the owner has is an agreement from you to replace it some point in the future with the identical good. In most cases you would have the short sale proceeds (likely segregated or with some rights to owner is what I’d expect in this case). Also a short sales works for a commodity but not a perishable, which wine is. Just one reason you don’t see this nor is it practical. I’m not including retailer who do this for short periods of time 
No efficient way to short wine I know. You can sell what you own but if you own no Lafite and want to short Lafite no luck. Pretty much the same with any more unique collectible out there. In fact shorting stock as a retain investor is a pretty poor value as the short seller usually doesn’t earn interest on proceeds which is highway robbery.
Brian Grafstrom, the other party would gain whatever I would be willing to pay them in exchange for the right to hold their wine for a decade. I would sell the bottle to somebody else as soon as I receive it, invest the proceeds in, say, a Treasury bond in the meantime. When the decade’s up, I would buy an identical bottle back from the market and return it to its owner. If the bottle’s price has declined (by a greater amount than the gap between my Treasury-bond interest and the amount I pay to the owner), then I make money.
John Sprow, in terms of the owner’s counterparty risk regarding me, that only comes into play if I go bankrupt, right? If I show the owner my assets and income and he is satisfied that I’ll remain solvent, then if I don’t fulfill my end of the transaction he can just sue me, and expect to get his legal costs charged to me when he wins. (Of course, that still presumes that I don’t lose my job and/or all the assets I showed him during my decade-long holding period). Yes, wine is eventually perishable, but how does that factor in to a trophy wine aging from 28 to 38?
hmm, ok. Thanks for the reply. ![[cheers.gif]](/uploads/db3686/original/2X/0/0ff9bfcdb0964982cd3240b6159868fbdf215b1a.gif "cheers"){kind=small}
Dan,
The counterparty risk is
- Will he be able to find you?
- Will you be dead?
- Will you have assets to cover?
- Willingness to pay?
- What legal rights?
- Enforceability of above?
- How provenance determined of an “unknown” bottle delivered forward?
- Rights of the orig owner if above not met satisfactorily?
- Enofrcability of above…
As simple as this trade might sound it would be amazingly complicated to draft a good agreement here from the “owner” perspective. The short seller however would be long a variety of options and I’d like that side of the trade
What about margin calls? Think about why you can easily short in your retail stock account - the broker holds your cash, keeps your margin at a certain level, and the moment you can’t meet a margin call they can get out of the trade (ie buy you in) with minimal loss. At the very least I would think you would have to fully collateralize the repo - ie you would have to let them hold all of the proceeds from your selling the wine.
Too bad. Maybe short selling would help restore sanity to the market.
One attempt to short-sell collectible wines:
http://www.winespectator.com/webfeature/show/id/Rare-LLC-Trustee-Held-Accountable-for-Wine-Futures-Sales-Gone-Wrong-_3484
Instead of having them hold the short proceeds (which I’d want to reinvest in something else), couldn’t I secure the loan by giving them a lien on my house or something?
Victor maybe there’s an opportunity to start the WCC or Wine Clearing Corporation. They could store wines, guarantee provenance and elimiate counterparty risk.
Victor still has room in his fridge for a few bottles. Perhaps he could hold escrow?
Thinking about this a bit more, perhaps the best idea is just to do this as a cash-settled futures with periodic margin calls. You could fix a discount rate at inception and calculate the forward based on auction prices. The only risk is that one of the counterparties walk away in between margin calls, which should not be that big a risk. So basically instead of shorting a stock, this will be more like shorting oil out the curve.
Almost anything can be priced. You could do this as a synthetic (removing the provenance issue) as long as you agreed on a source to derive a value for wine. There are services that provide quotes on wine prices. However 10 years is a long time and the wine has a volatile history so I think you would find the cost to do this transaction would be too high. Play around with a Black-Sholes model and put in 10 years and you will see the effect of 10 years on the cost - although I should point out Black-Sholes would not be appropriate to value this because if I understand your example you would only be required to replace the bottle in 10 years and the holder of this option could not “call” it before then, whereas Black-Sholes assumes the “option” can be called at anytime.
If collectible wine does not have log-normally distributed returns, the Black-Scholes model would not work. Also, a binomial model may be problematic, by assuming that wine prices can be efficiently delta-hedged. Finally, this trade would not be an option, but a forward. One would need a means to imply no-arbitrage forward pricing.