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If they had done REAL analysis on market history,
they would have "seen" the "flight-to-safety" condition that occurs once
every few decades......
when the equities tank, and the bonds soar.
It would have only taken ONE DAY for them to see that condition
arriving.....thus avoiding that 500 million dollar loss which occurred
subsequently.
> -----Original Message-----
> From: Lawrence Price [mailto:lprice1023@xxxxxxxxxxxxx]
> Sent: Wednesday, February 16, 2000 9:20 AM
> To: Omegalist
> Subject: Re: Trillion Dollar Bet - anyone impressed ?
>
>
> In the late seventies and early eighties, I was one the pack that
> was involved in
> creating these kind of strategies. It became clear to me that
> ultimately all of the
> ideas came down to the ability to wait for markets to return to
> their theoretical
> value. That meant that capital allocation was the most important
> part of risk
> management. However, in order to earn the kind of return that we
> had envisioned, it
> meant entering into positions of a size that were in the bell
> curve of safety
> provided the market behaved in a ordinary way. The extraordinary
> move would break
> the firm. Finally, infinite capital is required. That is why I
> sold my firm. I
> was sure that sooner or later a bust would happen.
>
> THE DOCTOR wrote:
>
> > You are correct that LTCM was short bonds. The traded the
> correlation of bonds
> > to big cap equities. If you look at the market back then, one
> of the position
> > that created the greatest headache was when bonds and stock decoupled.
> > Regrettably their equity choices went decoupled from bonds when
> rates and
> > equities decoupled. They played rates against their
> correlation to big cap ...
> > when rates go down you expect stocks to rally ..... when rates
> go up you expect
> > stocks to sell off. Pat of their challenge was a "brief"
> decoupling. When you
> > are heavily leveraged .......... relatively modest loses of
> correlation can be
> > devastating. The point that many people missed from the piece
> was they almost
> > never never traded any outright direction bets ... what they
> used their "models"
> > for was to calculated the expected correlation and the delta
> hedges to benefit
> > from the moves. When you trade that way and lose correlation
> .. unless you
> > have enough capital to survive ... YOU DIE.
> >
> > BruceB wrote:
> >
> > > 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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