Via WhereIsBeeks.com by David Von Leib
As excerpted from Not My Grandfather’s Wall Street by David von Leib, America Star Books, 2015:
Here’s what Charlie Munger had to say at the Daily Journal meeting
Charlie Munger spoke at the Daily Journal Corporation's Annual Meeting of Shareholders today. Although Warren Buffett is the more well-known Berkshire Hathaway chief, Munger has been at his side through much of his investing career. Q4 2020 hedge fund letters, conferences and more Charlie Munger's speech at the Daily Journal meeting was live-streamed on Yahoo Read More
The year was 1992. The locale: a prominent office building on Broad Street, New York City. The precious metals trading desk.
Also see pripr articles from Von Leib on ValueWalk:
Not My Grandfather's Wall Street: Diaries of a Derivatives Trader by David von Leib
Jimmy loved chances to front-run customer business. Once through personal connections, the head of the options desk, a guy named Paul, had gotten a huge order to buy several hundred million ounces of silver for Kodak to fulfill their annual photographic paper needs. Paul had only received such a big order because the Kodak Treasurer trusted him implicitly. But Paul ran the options desk. Jimmy ran the spot metals desk, so technically, this order had to be handled by Jimmy – not Paul.
And with Jimmy controlling the levers, it quickly became an exercise, well…in customer rape. Jimmy would get 40 to 50 million ounces of silver bought, and then ask Paul to tell Kodak that he’d only been able to get 15 million done up to the Kodak limit. Jimmy would suggest raising that limit a bit. Paul would sheepishly follow instructions – embarrassed a bit as he did so – and tell his Kodak friend that the market was thin and not that much size had been available. An amended higher price limit from the Kodak counterpart would typically be obtained. Then the process would repeat itself: one ounce of silver for Kodak compared to two ounces of silver for the Goodman house account. Of course, if silver ever started to back off a bit, that allocation mix could magically be adjusted and leave Kodak with a far bigger fill.
It was all a classic Jimmy-style of doing things. Thorn had to give him credit – he was almost a master at front-running. Kodak got their silver in the end, but the teeth-pulling way that they did so was embarrassingly slow and the all-in fill certainly ended up at higher prices than should have naturally transpired.
In another instance during that era, there was a large CTA named John Henry & Co. who would periodically come into the gold market and trade a mechanistic trend-following model. John Henry’s sizes were generally too big for the gold market and caused significant skid every time that his traders had to make an adjustment or reversal in exposure. Correctly anticipating what day John Henry would be trading and at what price level could be a huge advantage to anyone with a front-running mentality.
So Jimmy was astute enough and cravenly enough to make that happen.
Calling two Russian-born quants into his office, Jimmy had said: “Here, take this diary into your back office, and study the dates where I noted John Henry came into the gold market for size. Then retrofit his model. I want at least 24-hours advance notice of when he might next pull the trigger, and at what price level.”
So for several months the two Russian guys had toiled away trying to retrofit John Henry’s past trading behavior to come up with a model that would predict his next action.
One day the quants emerged from their office.
“We think John Henry is currently long gold from around $328,” the taller of the two quants offered.
“Yes, yes, that feels about right. He bought those several weeks ago. Gold’s now $348; he’s $20 bucks in the money. When’s he going to be forced to flip?” Jimmy responded.
“If gold touches $344 today or tomorrow, we think his model will trigger.”
“Good info. Thanks. I hope we get the chance to see whether you are right,” Jimmy said, with a new glint of excitement in his eye.
The next action had been for Jimmy to call down to the COMEX gold futures floor broker.
“Stevey – I’ve got an assignment for you. Keep your eye on the Dean Witter broker – you know, the one who does all the big-sized orders for John Henry. If you see the price of gold touching around 344 and that Witter guy raises his hands to sell anything, I want you to start selling in front of him. You have a standing order to begin with 500 lots before you even tell us what is going on. But make sure that you let us know pronto. Got it?”
And so a day slipped by and nothing had really happened. Gold sagged a buck to $347. The next day it sagged another buck to around $346. Quiet volumes. Sleepy summertime trading.
Jimmy went back to the Russian quants on the third day. “Where do you think he pulls the trigger today?”
“Could be a bit higher. Maybe $345 will do it.”
Jimmy had eyed the COMEX screens: $346 to 346.20.
He decided to have a bit of fun – give the market a push. See if he couldn’t get this thing into motion.
“Stevey – remember that order from the other day. I want you to keep working it, but raise the threshold a bit. If you see Dean Witter in motion trying to sell anything around $345, just don’t let him out; sell in front of him….”
A moment later he continued.
“Now how hard do you think it would be to get this market to print $345?”
“If I offer out a few hundred lots in a sloppy fast fashion, that would likely do it.”
Jimmy eyed the desk and the screen. He wanted everybody ready. “OK guys. You understand the drill. If we hear Witter selling, Stevey’s going to keep the pressure on downstairs. I want everyone calling out to their assigned counterparts and selling at least 20 bars of gold apiece. This will be fast and furious. Everyone ready?”
There was nodding around the desk as people clutched their phones.
“OK, Stevey ─ give it that push. Sell 500 lots and butcher it. I want a 345 print. And if Witter comes, just keep going with that other standing sell order that we talked about.”
The squawk box crackled back: “Going into motion…selling 500 in a rush…At 6, sold 50; at 5.80, sold ‘nother 50. At five-and-a-half, making some noise now. Phibro takes a hundy from us. I just gave him another hundred. Looks like that shut him up. He’s done. Still offering 5.5, now at 5.30, at 5.10. Printing 5’s.”
There was a moment of silence. Sweat was notably pouring off the forehead of one Russian quant standing behind the desk. Two months of work hung in the next few seconds – It might make a difference between whether the quant still had a career at Goodman or not.
“Witter trying to sell 500!” Stevey shouted at last. It was the moment of epiphany.
“Don’t let him out. Go, go, go…everyone call out. Sell.”
A cacophony of outgoing phone calls followed, while Stevey continued shouting over the COMEX box.
“At 4.5, 4’s trade, at 3.5, at 3,” “We sold another 500. Witter hasn’t sold anything yet.”
“Don’t let him out. Sell another 1000. Go. Go. Go.” Blood vessels emanated from Jimmy’s forehead as he shouted into the phone. He was spitting into the phone, his face beet red.
“Selling another 1000.” Stevey confirmed. “At 2, at 1, at 0! Jeezus. What a hole. At 438, at 7 now. Witter still has his hands up. I don’t think he’s sold anything yet.”
“Do it again – another 1000.”
It had been almost magical watching Jimmy in motion – he was like a professional orchestra leader leading a market fuck-fest.
After 434 was touched, Jimmy slowed down his pace of selling, and then let Witter get some lots out the door. By the time 428 and then 427 were reached, Jimmy was taking back gold from Witter’s desperate belated attempt to complete his order. What a skid! John Henry had started with a winning trade $20 in the money, but courtesy of Goodman, they were not getting out much better than flat.
Nothing illegal done. Just street smarts and cunning applied to a bit of programming by some Russian dudes. Thorn thought the moment reminiscent of the final scene of the 1983 movie Trading Places ─ the only difference being that this was real, not Hollywood make-believe.
But Jimmy wasn’t just known for front-running outside counterparts. Sometimes, he would front-run his own in-house traders. There had been another day when a tall slightly laid-back in-house prop trader named Bennett had sauntered over to the gold desk to ask Jimmy his opinion of the market. Bennett, like John Henry & Co., traded relatively systematically and was trying to apply models that he had successfully developed in the FX markets to gold. Bennett at the time was long gold.
“So what you think of the market?” Bennett asked Jimmy almost in a chit-chatty way.
“Gold’s a bit heavy. Might be some Russian selling sitting on top of this. Hard to tell. Where do you flip to get out?”
Bennett had responded that a price level about $3 below the then-current spot price as his trigger point. Bennett then slowly started to saunter back to his own desk. No sooner than he had turned his back on Jimmy, but Jimmy had started to push gold lower. Yes, maybe there was some Russian selling around, but Jimmy saw red meat on the hook with his own in-house colleague.
By the time Bennett had returned to his own desk, Jimmy had caused a $4 skid in gold all by himself.
Bennett had come rushing back, a bit flushed. “Russian selling?”
“Looks that way, man. Jeez this thing is really weak.”
“Sell me two tons of gold at the market.”
“Look Bennett,” Jimmy replied, “This thing is really fragile. It’s down $4 on nothing in just a few moments. I’ll do you a favor and take your two tons from you basis down another $2 from here. That’s the best that I can offer you man. I think you’ll do better accepting this internal trade than if I go start hitting bids. I’m doing you a big favor man.”
Bennett agreed to Jimmy’s proposed “basis trade” or internal transfer between their accounts.
Yeah, some favor. Bennett electing to sell out his gold to Jimmy just helped Jimmy cover the short that Jimmy had put on to trigger Bennett’s stop. It was all just the same game as had transpired with John Henry, but applied in-house. As compared to the John Henry episode which had been somewhat beautiful, it made Thorn feel ill to watch this all transpire from his nearby options desk perch: one Goodman guy taking advantage of another Goodman guy. Any limited respect that Thorn had for Jimmy diminished after that.
Thorn’s own time in the hot-seat with Jimmy soon followed in the fall of 1992.
“Hey Thorn, you’re long copper vol, right?” Jimmy had asked one day in an excited fashion. “I think I have a customer who wants to buy some options. That suits, right? You’ve got the inventory to go?”
The entire group was still struggling to recover from a year of stultified markets and Paul having hung himself on that cross of gold volatility. But copper volatility was indeed cheap at around 7.5% vol levels – a historically low extreme. Thorn had bought a few at-the-money options. He was happy with the position, but his job was to be a market-maker, and he was always interested in someone willing to pay the offered side of the market.
“Sure, Jimmy, what you got?”
“Well, it’s a forward-start one-year average rate put, but it don’t start averaging until January 1 next year. I guess that makes this an exotic option. The guy says it’s roughly a 10 delta put. He’s got some pretty big size to buy.”
“Who’s the customer?”
“Big mining house – Freeport.”
“What’s the size?”
“I think he said a million tons.”
“Holy shit. That’s like the entire annual production of the U.S.” Thorn was sitting up on the edge of his seat by this time.
“I told you I had a buyer.”
Thorn got more specific details of the proposed deal from Jimmy and punched up the pricing in his computer.
“Jimmy – There is a price for everything, and I will put a price on this, but you have to understand something first – this 10 delta stuff for this size is like toxic waste. It could really bite us in the ass. Because of the forward start nature of this option, yeah, it’s an exotic option, and won’t be easy to hedge or back-to-back with anyone else on the street. Plus we’d be selling this just off historic lows in copper volatility. If copper happens to fall precipitously sooner rather than later, I can’t guarantee Goodman won’t be liable to lose like maybe, $30 million. We should think twice about putting this thing on our books.”
“Hold on a sec,” said Jimmy. “Let me understand this. You guys have been dying on the vine long metals volatility. That ass-hole Paul drops $20 bucks long gold vol. You’re now long copper vol, and you don’t want to accommodate a customer who wants to buy some volatility?”
“Jimmy – as I said, I will put a price on this thing. But we have to be super conservative given the nature of what Freeport is asking for. This is like apples and oranges. Sure, I’m small long some three-to-six month at-the-money copper options, but that has nothing to really do with selling a boatload of 10 delta 15-month options with bells and whistles attached. I’m just giving you my two cents on this. Not every piece of customer business is an opportunity. Some is more of a liability. Maybe this is something that we should take a pass on.”
“No fuckin’ way we’re passing on this business.” Shot back Jimmy. “I want to win this business.”
This entire discussion was consistent with Jimmy’s front-running mentality, but applied to a market and a circumstance that he did not really understand. “So what you thinking for a vol price?”
“Well, the normal at-the-money options are 7 vol bid at 8. But the COMEX vanilla back-end low delta puts are trading more like 9.5. For the size and the exotic features of this thing, I wouldn’t sell it lower than 11 vol.”
“Should I show the customer that? How much money would we make mark-to-market there?”
“Marked to the COMEX 9.5% vol level, you’d book up an up-front gain of like $3 million, but it would be all fake, not something that we could lock in. As I said, this option could then still bite us in the ass in a much bigger way. I’d rather let Pierrepont or some other bank win this biz Jimmy. I really would.”
Jimmy bristled yet again. He just didn’t understand how someone couldn’t just love customer business. Wasn’t it always an opportunity to rip someone’s eyeballs out? Shit, if Thorn said they could book a $3 million gain marked-to-market, wasn’t this worth doing every day of the week? Jimmy was mentally thinking that he’d even be happy with a $1 million mark-to-market gain. He didn’t really understand the contingent liability nature of running an option’s book.
“So you want me to show 11% vol offer – is that the fair offer? I want to win this thing. Don’t embarrass me with this guy.”
“I think 11% vol is something that I could live with. But I doubt if Freeport is going to like that price.”
“Fuckin ‘a. He better like the price. You better not be dicking me on this one.”
And so Jimmy had gotten on the phone to his counterpart at Freeport. Thorn heard the long drawl of a southern accent come on the line. Jimmy showed the 11% volatility offer.
“Shit man, you think I’m some hillbilly out here in the hinterlands who you can just take advantage of?” came the Freeport treasurer retort. “I know where volatility levels are. 11% vol is like a rip-off level, man. And I thought you guys said that you were players?”
Jimmy – face slowly turning beet-red – glared at Thorn as he clicked off the phone mic. “I thought I told you to win this thing, dickwad.”
“I told you Jimmy that I doubted he’d like the price, but you really don’t want to sell this thing. There is no liquidity in the market to cover it. I don’t care how much money we book up-front. It’s just not worth it.”
“So you got no room to improve this price? You heard this guy – he thinks we’re ripping him off.”
“Look, if you sell this thing any cheaper than 11% vol, sure, you’ll book some up-front gains. At 10 vol, you’ll still book $1 million versus a 9.5% mark. But you won’t be able to cover this option there. No way in hell. And I won’t take any responsibility for it. You’re flying solo on this Jimmy.”
Jimmy thought for a second, and then clicked back on the phone line.
“Hey buddy, looks like there was a mis-communication on this end. My trader said this is doable at 10% vol, not 11%. I misheard him initially.”
Thorn looked to the heavens. Fuckin’ Jimmy was in over his head ─ didn’t know what he was doing. Anger was slow to well up in Thorn normally, but he slammed down a sheaf of risk reports that he was holding, and marched out of the trading room.
When he came back, Jimmy stared at him, and then called him into his office.
“Thorn, you are a thoughtful guy. I know that you are also at heart a conservative guy trying to do your best to trade for Goodman. But I almost just made a complete ass of myself in front of that client. When I tell you to be competitive, that’s what you’re supposed to do. I also didn’t get any sense of team support when you just left the room. I think your days at Goodman are over. You’ll get a nice parting bonus. I think you’ll be pleased. But I don’t want you on my team any longer. Start packing up your things.”
“Fuckin right, I’ll pack up my things. Good luck with that option by the way.”
Thorn left the room and went back to his desk where he quickly started filling his briefcase with odds and ends of things that he wanted to keep.
Thorn had been in the wrong seat at the wrong time. Putting up a stink, he’d gotten himself fired. If he’d put up less of a fuss, he would have gotten stuck with an unhedgeable tail risk exposure on his watch. It was just one of those lose-lose type of propositions. Working near Jimmy certainly seemed like another lose-lose position longer term. It was probably a good thing to push on.
All Jimmy knew was that he had a $1 million up-front gain to show for the day’s work, a happy client, and one less guy predisposed to long volatility on his payroll. He’d get someone else to figure out how to hedge that damn option. It couldn’t be that hard to hedge, could it? After all, Goodman had plenty of smart guys around.
Copper dropped precipitously in April 1993. Volatility exploded. Somewhere half-way around the world, there was a trader long copper at Sumitomo Metals that was also quietly getting screwed.
Consistent with Japanese non-mark-to-market norms, the world would only find out about these losses several years later.
The Freeport option booked out by Jimmy eventually cost Goodman over $13 million in losses. At that point, the story behind the loss got morphed, of course.
“This was a legacy position left behind by Thorn,” Jimmy told Blankstein. “We’re doing our best to cope with it.”
Yup, that Jimmy was quite the Wall Street shark – he never saw a patsy that he didn’t hesitate to carve up. Thorn had been his sacrificial Thanksgiving turkey.
As excerpted from Not My Grandfather’s Wall Street by David von Leib, America Star Books, 2015
Article by Where is Beeks