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I followed the LTCM debacle pretty closely in the WSJ and other periodicals,
and I think the biggest part of the story least talked about was how so much
of what happened was a classic squeeze play. I won't argue with the good
Doctor about how the trades were actually implemented, but I do know that
LTCM was heavily short US Bonds, and was heavily leveraged. That part most
people know.
What is left out of that statement is that EVERY major investment firm found
out about this situation, and decided to move in for the kill. They started
buying bonds, with the underlying trend, knowing that LTCM didn't have the
cash to meet the imminent margin calls. When those margin calls came, LTCM
would be forced to start buying back those bonds, a buying spree the other
major traders would be more than happy to sell into (at an enormous profit).
This just goes to show that, despite what the press would like us all to
believe, the super-rich and successful traders are not one big happy family
who conspire against the rest of us. They are more like a pack of sharks,
who will work with each other when it's in their best interest, but won't
hesitate to turn on each other at the first sign of weakness.
When Greenspan called all the parties together to arrange some type of
peaceful settlement, many of the big traders were against the idea. Not
because they thought owning a piece of LTCM was a bad risk, but rather
because they were being deprived of the financial windfall that would have
come with LTCM being forced to "play by the rules" and be destroyed.
In hindsight, the LTCM trades were actually pretty good. Bonds have been
falling in price virtually since the very day the attack on LTCM was called
off. I don't know much about complex option hedging, but it seems to me
it's pretty hard to factor into your risk models the possibility that the
entire big stakes investment world will turn against you for the sole
purpose of your complete destruction...
Bruce
----- Original Message -----
From: "The DOCTOR" <droex@xxxxxxxxxxxx>
To: "Lawrence Chan" <stnahc@xxxxxxxxx>
Cc: "Omega-List" <omega-list@xxxxxxxxxx>
Sent: Tuesday, February 15, 2000 4:24 PM
Subject: Re: Trillion Dollar Bet - anyone impressed ?
> Your analysis of LTCM is incorrect. They were not OTM option sellers.
They
> were dynamic hedgers and very little unhedged option trading was involved.
> Delta hedging doesn't work if prices are not continuous...add the leverage
and
> that is what killed them. Think of a covered call write with huge
leverage.
> Image what happens when the stock gaps down and the volatility goes up.
You end
> up losing money on both sides of the position. The gap ... non
continuous
> pricing .... means you can't adjust your hedges. Modest moves can be
> devastating because of the size of the positions.
>
> Lawrence Chan wrote:
>
> > the whole story was detailed in a book.
> > will find the title and post it.
> >
> > they basically sell some very very out strike options on some
> > exotic derivatives and bonds at a dirty cheap price, but
> > in HUGE SIZE all the time.
> >
> > so when the mkt start going against them FAST,
> > which is the key problem for option sellers, they cannot do
> > a thing but just watch themself sink.
> >
> > plus, they thought (like all option traders) the first move
> > against them is normal ... like 99% of the other trades they did,
> > the mkt SHOULD return to the original level ...
> >
> > Thus the mkt condition did not change against them, its just that
> > they failed to calculate the option price properly - using chaotic
> > assumption, instead of the stupid B.S. model :)
> >
> > With chaotic model, you do not sell very very out strikes, because
> > their prices instead of going very cheap, they can go inifinite in
> > many cases :)
> >
> > The moral is to LONG these cheap options at a rediculously cheap
> > price from time to time as lottery tickets .. who knows what will
> > happen :)
> >
> > I do know a friend who use part of his job salary to buy dirty cheap
> > options on OEX (before) and sp future options (now) every month.
> > He is toasted 90% of the time, but his net gain is in the millions mark
:)
> > like last nov, dec, and the jan this year - he made back all the bets
> > he made in the past 2 years plus more.
> >
> > back to LTCM, as they are a fund, they are forced to perform,
> > thus, lottery type of trading cannot be used as the clients will go mad
> > on them ...
> >
> > -Lawrence Chan
> >
> > ----- Original Message -----
> > From: M. Simms <prosys@xxxxxxxxxxxxxxxx>
> > To: Omega-List <omega-list@xxxxxxxxxx>
> > Sent: Monday, February 14, 2000 9:59 AM
> > Subject: Trillion Dollar Bet - anyone impressed ?
> >
> > > Last week's airing on PBS of the LTCM debacle was interesting in that
> > very,
> > > very little details of the fund's techniques were unveiled. In fact,
it
> > was
> > > kind of stupid when it was mentioned that LTCM dropped $500 million in
one
> > > day.....yet gave no clue as to how that was actually accomplished. It
was
> > > probably a trading "record".
> > >
> > > Obviously these guys were leveraged with options and/or futures in
such a
> > > way that long and short "bets" were supposed to offset each
> > other......based
> > > on prior relationships.....
> > >
> > > Moral of the story: backtesting alone won't hack it in the long run.
When
> > > economic or market conditions change drastically, make sure your
system
> > > either adjusts properly or STOPS TRADING.
> > >
> > >
> > >
>
>
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