News Articles
John
For Release: April 18, 2005
FEDERAL COURT ISSUES ORDER FREEZING ASSETS OF FLORIDA FOREIGN CURRENCY
TRADING FIRM AND ITS VICE-PRESIDENT; BOTH CHARGED WITH FRAUD
U.S. Commodity Futures Trading Commission Charges Defendants G7
Advisory Services, LLC and Michel Geraud With Fraudulently Soliciting
Customers to Trade Foreign Currency Options
Washington, D.C. - The U.S. Commodity Futures Trading Commission
(CFTC) today announced that on April 12, 2005, a federal court in
Florida entered a statutory restraining order against defendants G7
Advisory Services, LLC of Boca Raton, Florida, and Michel Geraud, also
known as Mike Jeraux, of Pompano Beach, Florida, freezing their assets
and preventing the destruction or alteration of the firms books and
records.
The court's order arises from a complaint filed the same day by the
CFTC, which alleges that since at least May 2004, defendants have
fraudulently solicited customers by telephone and through the website
www.g7options.com, among other means, to trade foreign currency
options.
According to the complaint, G7 Advisory provides its brokers with a
sales script entitled Currency Sales Success-the Complete Guide to
Selling Currency Investments Around the World to use when soliciting
customer to invest. As alleged, the script instructs brokers to stress
the urgency of investing immediately, to portray an investment with G7
Advisory as highly rewarding with little risk, and to convey the image
that G7 Advisory's traders are experienced and successful.
However, according to the complaint, the defendants in fact
misrepresent and/or fail to disclose the likelihood of profits and the
risks of trading foreign currency options, as well as the trading
experience of their brokers. The complaint alleges that, despite making
glowing profit representations and minimizing the risk involved,
defendants fail to disclose to potential customers that the firm has an
abysmal track record: 100% of G7 Advisory customers lost money since
the firm opened for business.
The Honorable William P. Dimitrouleas of the U.S. District Court for
the Southern District of Florida ordered a hearing on the CFTC's
motion for a preliminary injunction to take place on April 21, 2005.
In its ongoing litigation, the CFTC is seeking a permanent injunction
against the defendants, repayment of defrauded customers, the return of
ill-gotten gains, and monetary penalties for violating the Commodity
Exchange Act.
The CFTC appreciates the assistance of the Broward County Sheriff's
Office, Strategic Investigations Division, the Boca Raton Police
Department, and the Florida Department of Agriculture and Consumer
Services in this matter.
The following CFTC Division of Enforcement staff members are
responsible for this case: Rachel Entman, Lacey Dingman, Jason
Gizzarelli, Gretchen L. Lowe, and Richard Wagner.
Media Contacts:
Alan Sobba, (202) 418-5080
David Gary, (202) 418-5080
Office of External Affairs
Staff Contact:
Gretchen Lowe
Associate Director
CFTC Division of Enforcement
202-418-5379
John
regarding option traders.
http://www.888options.com/news/presentations/harris_study_2005.pdf
John
John
For Release: April 28, 2005
UNITED STATES COMMODITY FUTURES TRADING COMMISSION CHARGES THREE
DEFENDANTS IN FLORIDA AND ONE DEFENDANT IN CALIFORNIA WITH FOREIGN
CURRENCY OPTIONS FRAUD
Amended Complaint Alleges the Defendants’ Activities Caused Losses of
More than $5.8 Million to at Least 350 Customers
WASHINGTON -- The United States Commodity Futures Trading Commission
(CFTC) announced today the filing of an amended complaint charging
defendants Graystone Browne Financial, Inc., of Miami, Florida; STG
Global Trading, Inc., of Los Angeles, California; QIX, Inc., of North
Miami Beach, Florida; and Joseph Arsenault, of Miami Beach, Florida
with violating the antifraud provisions of the Commodity Exchange Act
in a case already pending before U.S. District Judge Joan Lenard in
Miami, Florida.
The pending action, initially filed on June 7, 2004, charged the
above-named defendants with the offer and sale of illegal off-exchange
foreign currency (forex) transactions, in violation of the Commodity
Exchange Act (CEA). The pending action also charged three other
defendants, Sterling Trading Group, Inc., Universal FX, Inc., and
Andrew Stern, all of North Miami Beach, Florida, with defrauding
customers by misrepresenting risk and failing to disclose losses, in
violation of the antifraud and other provisions of the CEA. (See CFTC
News Release 4946-04, June 29, 2004.)
The CFTC's amended complaint, filed on April 15, 2005, alleges that
Graystone and STG Global defrauded customers using misleading sales
solicitations materials and aggressive, high-pressure, misleading
telemarketing sales tactics to fraudulently solicit retail customers to
engage in illegal forex options. The amended complaint further charges
Arsenault and QIX with liability for the fraudulent conduct at
Graystone and STG Global.
The court previously entered a restraining order against the defendants
on June 9, 2004, that ordered books and records of the defendants be
preserved, and that required the defendants to provide access to
Commission representatives to inspect any such books and records. The
CFTC’s motion for preliminary injunctive relief against defendants is
pending before the court.
As alleged in the amended complaint, the activities of all the
defendants caused losses of more than $5.8 million to at least 350
customers. The amended complaint seeks a permanent injunction,
restitution, disgorgement, civil monetary penalties and other equitable
relief against each of the defendants.
The following CFTC Division of Enforcement staff members are
responsible for this case: Peter M. Haas, Eugene Smith, Kyong J. Koh,
and Paul G. Hayeck.
John
http://quote.bloomberg.com/apps/news?pid=nifea&&sid=asibq1F2VEMk
John
funds
According to Financial Post - Canada, Hedge funds attracted a record
US$27.4-billion from institutional and wealthy investors in the first
quarter, helping to push assets to more than US$1-trillion for the
first time, according to Hedge Fund Research Inc. Money streamed in
faster than at any other time since Hedge Fund Research began gathering
data in 2000, topping the fourth quarter's US$27-billion. Net inflows
and an average return of 0.9% in the first quarter increased assets to
US$1.01-trillion, Chicago-based Hedge Fund Research said yesterday in a
statement. Pension funds, endowments and other institutions have been
pouring money into the loosely regulated private pools to increase
returns and diversify their investments. Late last year, the
US$3.5-billion Eton Park Capital Management LP, founded by former
Goldman Sachs Group Inc. partner Eric Mindich, became the largest hedge
fund startup ever.
John
Controversial fund owes Canadian investors $750 million
KPMG finds $238 million in `unexplained offshore transfers'
MADHAVI ACHARYA-TOM YEW AND TONY WONG
BUSINESS REPORTERS
Controversial Toronto-based hedge fund Portus Alternative Asset
Management is more than $400 million in the red once the company's
assets are subtracted from its liabilities, according to documents from
the firm's court-appointed receiver.
Portus owes at least $1.09 billion, but has assets of only $664
million, according to a preliminary balance sheet provided by monitor
KPMG LLP in court documents.
According to the KPMG, Portus owes $750 million to Canadian-based
investors, another $83 million to offshore investors, and another $12
million to secured and unsecured creditors. The company also has $238
million in "unexplained offshore transfers," according to the receiver.
"We believe that there are other assets that have not been identified
or secured as yet, so this is a very preliminary look. We are still in
the process of searching," said a consultant to the receiver in an
interview yesterday.
The Toronto-based firm was shut down by the Ontario Securities
Commission in February and prodded into receivership in March, while
securities regulators across the country have been looking into the
company's sales practices.
While the receiver is still trying to determine its fiscal health, the
preliminary statement shows the hedge fund is still short about 40 per
cent of what it would need to pay off its debts.
"The receiver is not yet certain of the total assets and liabilities of
the Portus Group, due to factors including the complexity of the
structure, domestic and offshore wire transfers and the deliberate
destruction or removal of certain of the Portus Group's records," KPMG
said in its latest receiver's report.
"Consequently the receiver cannot yet determine the precise amount that
will be available to satisfy the claims of investors."
According to the report, Portus has $27 million in domestic and
offshore cash, with another $106 million still in brokerage accounts.
The bulk of assets are in Société Générale (Canada) bank notes of $529
million.
Meanwhile, investors hard-struck by Portus may get some relief. The
receiver is expected to ask an Ontario Court today for permission to
distribute up to $10 million to investors facing financial hardship
since the Toronto-based hedge fund company was shuttered by regulators.
KPMG has said previously that the minimum recovery investors could
expect was 62 per cent.
"It would be just and appropriate for the court to authorize the
receiver to take steps to address these hardship situations as soon as
possible," said the report.
"The provision of preliminary relief to those investors actually
experiencing hardship would not unduly prejudice other investors."
The hardship committee will have a three-person membership, including a
representative of the receiver, representative lawyer and a third
individual to be appointed by both the receiver and representative
lawyer, according to court documents.
The criteria for hardship would include clients who need cash to
"provide the necessities of life" and have limited "alternative sources
of funds available," according to KPMG. However, the maximum amount
paid to any one investor will not be greater than 10 per cent of the
investor's funds in the Portus Group.
Also, in an effort to get a handle on how much money was distributed
overseas, KPMG will ask the Ontario Superior Court for an order to
compel Paul Ho, a former vice-president of sales and service at Portus,
to provide information.
KPMG is interested in the international sales team that Ho was a part
of, with investors as far away as Hong Kong, Bermuda and Taiwan. The
international investors "appear to have been referred" to the Portus
Group through dealers located in Canada, said KPMG.
However, when contacted by the receiver, "Ho advised that he had been
instructed by management on Feb. 17 not to provide any information with
respect to Portus to anyone. The receiver is of the view that Ho will
not assist the receiver unless compelled to do so" by the court, said
KPMG.
At the top of the "must-see" list for KPMG is Portus co-founder Boaz
Manor, who has been in Israel since March.
"It appears that the only person that the receiver has identified thus
far with a full understanding of the international investment structure
is Boaz Manor," said KPMG, noting that despite a March 29 court order
directing him to do so, "Manor has refused thus far to make himself
available for examination by the receiver."
Manor last contacted the receiver on April 19 by telephone and said he
was in the process of hiring an Israeli lawyer and would advise the
receiver this week on what his position would be concerning an
examination by the receiver.
John
Levy accused of taking $16 million, much of which came from Sonoma
County investors
Wednesday, May 4, 2005
By MARY FRICKER
THE PRESS DEMOCRAT
ONLINE
Information about the Global Money Management hedge fund bankruptcy is
posted at www.gmmreceiver.com
Tightening the screws on the three men who ran a San Diego hedge fund
that collapsed last year amid allegations of fraud, officials have
wrested some money from two and are threatening a third with
imprisonment.
While the investigation focused at first on Milton I. Friedman, the
hands-on manager of the Global Money Management hedge fund, sights are
now trained on co-founder Paul Levy who took $16 million that didn't
belong to him, officials claim in court documents.
"The diversion was longrunning, systematic, calculated and
well-organized," said receiver Charles La Bella in a report to the U.S.
District Court in San Diego, which appointed him to sort out the
troubled fund's finances.
La Bella is demanding that Levy return the money to investors or face
possible imprisonment or fines. A hearing is set in district court May
11.
Levy denies any wrongdoing. He claims he and the third manager, Milt
Lohr, reported the fund's problems to securities regulators as soon as
they realized something was wrong. He has cooperated with investigators
and said he will return to the fund any money he withdrew that exceeded
his investment.
"We've cooperated all along and continue to cooperate," said Levy's
Phoenix attorney, Thomas Connelly. "Paul has always wanted to do the
right thing."
La Bella's efforts to find millions of dollars that are missing from
the hedge fund is important to investors, including 60 in Sonoma
County, who have feared losing most of their money.
The fund had 240 investors, who could lose $60 million to $70 million
of the $110 million they gave Global, La Bella said. Almost half were
clients of Zenith Capital in Santa Rosa, which put $39 million in the
fund for 115 Bay Area investors, including $9.8 million from Sonoma
County.
Of the money lost, $10 million to $18 million may be retrievable from
Levy and others associated with managing the fund, La Bella has said.
Global Money Management was a hedge fund managed by Friedman, who
touted 30 percent annual gains when he was actually losing half of his
investors' money. When some tried to withdraw and couldn't get their
money out, they complained to Levy and Lohr, who went to the Securities
and Exchange Commission.
The SEC seized the hedge fund in March 2004 and filed a civil complaint
in district court in San Diego accusing the fund and Friedman of
securities fraud. That investigation is continuing. It is separate from
La Bella's actions. Federal law enforcement officials are also thought
to be looking into the case.
Last week receiver La Bella notified investors he has reached
settlements with Friedman and Lohr and he has concluded Levy should
return $16 million.
Friedman denied the allegations against him but has accepted a $15
million judgment and has agreed to turn over all of his assets to La
Bella. They appear to be worth about $800,000, La Bella said, most
coming from the sale of Friedman's $2 million La Jolla home in
December.
Lohr, of Rancho Santa Fe, has paid La Bella $566,000 cash in his
settlement.
Levy has agreed to return any money he withdrew that exceeded his
investment. When his wife sold a $13.7 million Rancho Santa Fe horse
farm in June, he set aside $2.3 million to cover what he estimated he
might owe La Bella.
Forensic accountants working for La Bella concluded Levy owed $16
million and knowingly tried to cover up the difference. They said $10
million was investors' money that never even went to Global but instead
went directly to Levy, as described in court documents.
"The accounting was a sham," La Bella told the court.
At the same time Levy said he was cooperating with the SEC and La
Bella, he was hiring a law firm specializing in asset protection and
offshore trusts and moving money from a joint account with his wife to
his wife's separate property trust, La Bella told the court.
As recently as April 1, Levy called Zenith Capital president Rick
Tasker in Santa Rosa and asked him to change the ownership of shares
Levy owns in an investment that Tasker manages. Tasker said he did not
respond, and he reported the request to authorities.
Connelly said Levy will study the records that receiver La Bella has,
and if he agrees he owes $16 million, he'll try to pay it.
"I understand why the receiver made this filing. I think they want to
get everybody off the dime and get a resolution," Connelly said.
"That's fine. We'll continue to cooperate as we have been, and that's
all we can do. It shouldn't be forgotten who brought this to the
attention of the SEC."
You can reach Staff Writer Mary Fricker at 521-5241 or
John
Hedgefund.net
HedgeFund.net, reports Hakan Yalincak a New York University Student who
allegedly deposited $43 million in fraudulent checks, also talked
investors into placing $2.8 million in a bogus hedge fund.
The 21-year-old mathematics major, is being sued by two Connecticut
investors, Joseph Healey and Arthur Cohen for defrauding them into
believing he ran a hedge fund.
Yalincak claimed to have managed the Daedalus Capital Relative Value
Fund, which he said had assets in Switzerland and the Cayman Islands.
Court documents say Yalincak and a partner actually spent the money on
a new Porsche among other things.
John
May-10-2005 - The British Columbia Securities Commission banned Michael
Ernst Ruge and his firm, Chivas Hedge Fund Ltd, from trading in
securities for 25 years after he admitted lying to investors about the
scope and substance of his hedge fund, including returns and assets
under management.
The securities regulator for Canada's western-most province revealed
last week that Ruge admitted to falsely stating that Chivas LP was a
hedge fund that had "cream of the crop people" in a New York office
when there were, in fact, no New York employees.
Ruge also admitted to stating that Chivas LP had raised C$20 million
(US$16 million) in capital from investors in three different provinces
when he had raised only about C$1.5 million. He also admitted telling
investors that Chivas LP had a rate of return of between 26% and 45%.
What's more, almost none of the money raised by Ruge was used "as
contemplated by the offering memorandum" that Ruge presented to both
existing and potential investors in Alberta, BC and Ontario between
December 2001 and February 2003, the commission said.
All told, Ruge tapped some 50 mainly retail investors who were cajoled
into purchasing units of Chivas LP, which was not registered to trade
securities.
In the settlement with the BCSC, Ruge admitted he took close to
C$800,000 of investors' assets for himself, or placed it in companies
and individuals affiliated with him. Approximately C$240,000 was
refunded to investors, "but there is little prospect of additional
recovery and the investors have lost most of their money," the BCSC
said.
The fund's offering memorandum also overstated Ruge's personal
professional experience and qualifications, and falsely stated that
Chivas LP was a limited partnership in BC, the commission said.
Ruge, who is Chivas Hedge Fund Ltd's sole shareholder, director and
officer, has been ordered to pay a fine of C$150,000 and has been
barred from acting as an officer or director of any issuer for 25
years, except in "limited circumstances," the commission said.
John
Fri May 13, 2005 11:47 AM ET
BONITA SPRINGS, Fla., May 13 (Reuters) - The U.S. Securities and
Exchange Commission may require options markets to compile and publish
data on how efficiently customer orders are executed, a top official
said on Friday.
The SEC is considering a proposal to extend the so-called execution
quality rules to the options markets, said Elizabeth King, SEC
associate director of market regulation. Stock markets already follow
the rules.
Addressing the 23rd Annual Options Industry Conference here, King said
extending the rule would give brokers more information to help them
meet their obligations to their clients.
The SEC is also considering whether to reduce the options market's
present trading increments of five cents or 10 cents, depending on the
contract price, to one cent.
King said penny quotes would narrow bid-ask spreads. Penny-increment
trading was introduced in the stock markets more than four years ago
and has helped reduce payment for order flow, the SEC said.
Payment for order flow occurs when brokerages are paid by trading
specialists or exchanges to steer orders their way.
The practice raises questions about brokers' duty to get the best price
for clients, say critics of the current system.
But traders also say that options markets generate so much data that
penny price points could present a crushing capacity problem for
electronic systems.
John
options.
CME Announces Certified Options Partner Program
Thursday May 19, 11:18 am ET
Twelve Firms to Provide Front-End Solutions for Options Trading
CHICAGO, May 19 /PRNewswire/ -- As part of its initiative for
increasing the volume of electronic trading for options on foreign
exchange, equity indexes and interest rates, CME, the largest futures
exchange in the U.S., today announced the new CME-Certified Options
Partner Program listed below. This program fosters collaboration
between CME and the CME Options Program Partners so that enhanced CME
Options products and functionality are available to the marketplace
upon CME launch.
CME also plans to integrate the CME Enhanced Options System for CME
Eurodollar options into the CME® Globex® electronic trading platform,
which operates virtually 24 hours every trading day, later this year.
This enhanced options functionality for CME Eurodollars facilitates
trading of complex combination and spread trades typically used with
short-term interest rate options on futures within a fully transparent
and competitive execution environment.
"We work closely with key technology partners around the world to
provide our global customers with access to software that supports new
CME options products and functionality," said Rick Redding, managing
director, Products and Services for CME. "We developed the
CME-Certified Options Partner Program to ensure that all required
functionality is available for roll-out, to our mutual customers,
starting in the third quarter of this year."
CME has partnered with the following firms who have committed to
supporting the upcoming CME electronic options enhancements:
-- Actant*
-- Credit Suisse First Boston
-- Catus Technologies
-- FFastFill
-- GL TRADE*
-- NYFIX
-- Orc Software*
-- Prime Analytics*
-- RTS Realtime Systems*
-- Photon Trader
-- Random Walk Consulting
-- TradingScreen
*The following firms will provide the software to support mass quoting
and enhanced market maker protection functionality: Actant, based in
Zug, Switzerland; GL TRADE, based in Paris, France; Orc Software, based
in Stockholm, Sweden; Prime Analytics, based in Chicago; and, RTS Real
Time Systems, based in Frankfurt, Germany. For more information, please
visit http://www.cme.com/optionspartners .
John
For Release: May 19, 2005
U.S. COMMODITY FUTURES TRADING COMMISSION CHARGES OKLAHOMA RESIDENT
RANDY STEVE LANIER WITH DEFRAUDING CUSTOMERS
WASHINGTON, D.C. – The U.S. Commodity Futures Trading Commission (CFTC)
announced today the filing of an enforcement action in the United
States District Court for the Western District of Oklahoma against
Randy Steve Lanier, of Hinton, Oklahoma. The complaint alleges that,
between September 2001 and October 2003, Lanier misappropriated
customer money, made misrepresentations to customers, and distributed
false account information to them. Most, if not all, of the customers
allegedly either knew Lanier or were from Lanier’s area of Oklahoma.
Specifically, the complaint alleges that Lanier misappropriated more
than $164,000 by siphoning off funds from customer accounts located at
futures commission merchants (FCMs), and by soliciting customers to
give him funds to trade commodity futures and options and then stealing
the money by depositing it in accounts he controlled at Oklahoma banks.
The complaint goes on to allege that to conceal his theft of customer
funds, Lanier sent his customers fraudulent account statements and
fictitious Internal Revenue Service Forms 1099. According to the
complaint, these phony documents led many of Lanier’s customers to
believe that their trading accounts were very profitable. The complaint
also alleges that in making payments to customers who sought to
withdraw their funds, Lanier devised fake wire transfers to make it
appear that customer funds had been withdrawn from their allegedly
profitable trading accounts.
In its action, the CFTC seeks, among other things, repayment to injured
customers, the return of ill-gotten gains, monetary penalties, a
permanent injunction and trading prohibitions.
The CFTC thanks the United States Attorney’s Office for the Western
District of Oklahoma and the Internal Revenue Service for their
assistance in this matter.
The following CFTC Division of Enforcement staff members are
Richard Glaser.
John
really getting crazy.
John
John
Electronic systems are making the market more efficient -- and alluring
to investors
In the orchestra of financial instruments, options have long played
second fiddle. Institutions have used options for years to hedge their
investments, but beginning investors have struggled to grasp the arcana
of options contracts. And until recently, only a handful of firms have
made markets in options. Advertisement
Now, options trading is suddenly catching fire. In April the number of
contracts traded in the U.S. hit all-time daily and monthly highs of 11
million and 124 million, according to the Options Clearing Corp. Those
high-water marks come on the heels of a record year in 2004, when 1.2
billion contracts changed hands, up 30% from 2003. Some 91.5% of those
contracts -- which give the right but not the obligation to buy or sell
stocks and other items at predetermined prices in return for a premium
-- were for equity options based on stocks or stock indexes.
Indeed, stock-based options trading climbed faster than any other
category. That's a surprise. Stock prices have churned for months,
pulling volatility down to low levels. Normally options trading
benefits from high volatility, which increases both the premiums buyers
will pay for options and the potential profit on trades. But despite
low premiums and volatility, investors are happily writing call options
on stocks they own, so-called covered calls, to increase their returns
with little risk that their stock will either be called away or fall
sharply in price.
Also behind the surge is the rise of electronic systems that have made
trading far easier. This has encouraged institutions to hedge against
rising interest rates, falling oil prices, or an appreciating dollar.
Institutions now account for 50% of options trading today, vs. 30%
before 2000, says Michael Walinskas, executive director of the Options
Industry Council trade group. The new technology has allowed many hedge
funds to become market makers and drive large volumes of trades.
Citadel Execution Services, the broker-dealer affiliate of Chicago
hedge fund Citadel Investment Group, is the International Securities
Exchange Inc.'s (ISE ) biggest market maker, accounting for about 10%
of the exchange's revenue.
MORE LIQUID
E*Trade Financial Corp. (ET ) founder Bill Porter primed the trading
boom when he launched the first all-electronic options market, the New
York-based ISE in 2000. In just four years, it vaulted to No. 1 in
equity options volume. That pressured older markets such as the Chicago
Board Options Exchange to add electronic trading to their floor
trading.
As a result, options markets have grown more liquid. Because electronic
systems match buyers and sellers quickly and precisely, spreads, or the
gaps between offering prices and asking prices, have narrowed, making
trading more attractive. At the CBOE, which is still No. 1 in total
trading volume, average spreads have halved since electronic trading
began in 2003.
Electronic trading also has made it easier for institutions to make
markets in options. Market makers provide liquidity by holding
inventories of certain options for trading. Traditionally, they had to
maintain large staffs on trading floors -- an expensive proposition. On
electronic exchanges, that's not necessary. "You can make markets in
800 options with two people," says Joe Sellitto, director of derivative
products at E*Trade. Morgan Stanley (MWD ), which didn't make a market
in options before 2000, has become one of the largest market makers on
the ISE.
Retail investors, too, are contributing to the rise in trading volume.
At optionsXpress Holdings Inc., an online brokerage dedicated to
options investing, daily average revenue trades in the first quarter
were 20% higher than the same period in 2004. Although experienced
investors use options primarily to hedge bets on stocks, their
strategies are growing more sophisticated as they use online tools to
learn how to trade. At this rate, options won't play second fiddle
forever.
By Justin Hibbard in San Mateo, Calif., with Adrienne Carter in Chicago
John
Bloomberg News
Published May 26, 2005
A former Chicago Board Options Exchange trader on Wednesday was
sentenced to
more than nine years in prison and ordered to pay $21 million in
restitution
for using money and securities from investors to subsidize his trading
and
expenses.
Edward Thomas Jung was convicted of fraud in February 2004 for falsely
promising to invest his hedge fund customers' money in stock options.
The 60-year-old Jung was sentenced by U.S. District Judge Milton Shadur
to
109 months in prison and ordered to repay as many as 60 investors, said
Assistant U.S. Atty. Ed Kohler in Chicago.
Gregory Adamski, Jung's attorney, said his client was appealing his
conviction. Jung's investors were told that he was making trades
collateralized with their assets, and they could lose money, said
Adamski.
"Jung didn't do a good job of trading," Adamski said. "His position is
that
everything he did was fully disclosed and upfront, and that he has no
criminal liability."
Jung was indicted on securities and mail fraud charges in February 2003
as
the Securities and Exchange Commission increased scrutiny of hedge
funds,
loosely regulated private investment pools generally open to wealthy
individuals and institutional investors.
"The length of the sentence is appropriate for the crime and should
send a
message to the investment community," Kohler said.
Steve Fanady
Michael Catolico
and expenses". isn't that what he said he'd do with the money?
do people actually think they can invest in a risky business and not
lose ?
>
>
Pirate
play on the senior tour - (and he was good enough) but he got caught
in that spiral of losses and doubling up thinking he could make them
back and we all know how that goes....he totally played the legal side
wrong too - he should have plead guilty early on, got sent to a country
club prison, and been out by now... now he has gone thru most of his
money, owes even more, and will spend more time in prison.... a bad
trade all over....
John
Dan Ackman, 05.30.05, 11:00 AM ET
NEW YORK - Some fat-cat Wall Street lawyers figure they're underpaid
because the glad-handing investment banker across the table makes twice
what they do.
Some investment bankers figure they deserve larger salaries because the
doofus CEOs whose hands they hold make even more.
Chief executives have been known to compare their comparatively meager
paychecks to ballplayers, figuring if Shaquille O'Neal makes $30
million for stuffing a ball through a hoop, who can gainsay their just
rewards.
Ballplayers in turn note that they are entertainers, and no one
complains when Tom Hanks or even Adam Sandler (just to make it
completely ridiculous), makes $20 million on a single film, even a film
that remakes an old film and makes it much, much worse.
But there is another group that makes them all seem unrewarded: hedge
fund managers. According to a report in Institutional Investor's Alpha
magazine, the top 25 hedge fund managers earned at least $100 million
apiece in 2004. On average, the top 25 pulled in $251 million last
year. The top 25 CEOs: just $72 million.
Chief executives have something to grouse about: By Forbes' count, just
three CEOs--led by Yahoo!'s (nasd: YHOO - news - people ) Terry Semel
and IAC/InterActive's (nasdaq: IACI - news - people ) Barry
Diller--made $100 million or more last year. The third man on the list,
William McGuire of UnitedHealth Group (nyse: UNH - news - people ),
wouldn't crack the top 15 if they were running hedge funds, private
investment partnerships that can make outside gains sometimes by using
leverage and exotic derivatives.
I have heard the argument made in all seriousness that top CEOs are
underpaid by comparison to hedge fund managers. Here's how it goes:
General Electric (nyse: GE - news - people ) has about $750 billion in
assets. If its CEO was paid like a hedge fund manager--who typically
takes at least 1% of the assets and 20% or more of the profits--he
would be paid $750 million--oops, it should be $7.5 billion!--just for
showing up, plus a bonus if there was any profit. So what is GE chief
Jeffrey Immelt doing being paid just $12.6 million?
The nutty part is that a lot of these hedge fund managers didn't even
do well. Take George Soros, ranked No. 6 with income of $305 million.
The return on his Quantum Endowment Fund was just 4.6% net of expenses,
about half the return on the S&P 500, which was 9% in 2004. Several
others in the top 25 sported returns in the single digits. The top
earner among hedge fund managers was Edward Lampert, who reportedly
made $1.02 billion, the most in the magazine survey's four-year
history. He became known as the man who engineered the merger between
Kmart and Sears--now known as Sears Holdings (nasdaq: SHLD - news -
people ) and chaired by Lampert--helping his ESL Investments earn 69%
before fees.
Overall, hedge funds reported an 8.9% return on average (net of fees),
according to the Hennessee Group, a hedge fund consulting group. That's
about the same as an index fund, but hedge funds are a lot riskier.
Some of the huge incomes for hedge fund managers were due to their
investments in their own funds. (Institutional Investor does not
separate income from investment gains and income from fees.) Soros is
in that category, and so is his former protégé Stanley Druckenmiller.
For investors, it doesn't seem as if betting even with the biggest
stars in the hedge fund universe was particularly profitable, though
there were a few exceptions. Of course there should be some outsize
returns compared to mutual funds, because leverage adds some outsize
risk.
The returns for hedge funds are probably worse than is generally
stated. That's because the reporting of results is voluntary. Many
funds blow up and go out of business; others choose not to report in
bad years. Still others liquidate once they get into a hole, for fear
that they will never be able to earn the large success fees. The
promoters often simply start a new fund (see "The $500 Billion Hedge
Fund Folly").
There is every incentive, especially for up-and-coming promoters, to
make risky bets in order to establish a track record. If it works,
great; if not, start a new fund. It's heads-I-win-tails-you-lose. And
the winners win big.
John
Source: Alpha
Stephen Taub
[Below is an excerpt from Alpha magazine's Rich List featuring the 25
best-paid hedge fund managers. To view the full article and the entire
issue of Alpha magazine, including the Hedge Fund 100, click here to
subscribe.]
To make the list of the best-paid hedge fund managers, you had to make
$100 million — and that was in a so-so year.
Trying to impress New Yorkers with money is like trying to impress
Muscovites with snow: The stuff is just too commonplace. Yet never
before in the annals of wealth and power in Manhattan has there been an
upswelling of plutocracy quite like the ascendancy of hedge fund
managers. Even the most blasé Gothamites are taking note.
But then, never before have so few made so much so fast. Just to appear
on Alpha's 2005 list of the top 25 hedge fund earners required $100
million. To come out No. 1 took an astonishing $1 billion, a
distinction earned by Edward Lampert of ESL Investments. In all, the 25
hedge fund managers on our rich list reaped an average of $251 million
from fees and from gains on their investments in their funds. By
comparison, the CEO of a typical top 500 U.S. corporation hauled in a
measly $10 million last year. That $251 million, by the way, stacks up
nicely against the comparable figure for the hedge fund managers on the
2004 rich list: $207 million. Or that for the year before: $110
million.
Now, like the really rich before them, hedge fund managers are
asserting themselves beyond the business sphere: in the arts, in
politics and in society. And they are reshaping the upper end of the
markets in two commodities that ultra-affluent New Yorkers cherish:
fine art and luxury real estate. "Hedge fund managers are absolutely
the reason the art market is soaring," says Milton Esterow, editor and
publisher of ARTnews. Allan Schwartzman, an adviser to private
collectors and museums, calls hedge fund managers "voracious"
collectors.
Steven Cohen of SAC Capital Advisors (whose earnings of $450 million
put him at No. 4 on our top 25 list) has rapidly assembled a serious
collection of contemporary and modern art. He reportedly paid $52
million for a Jackson Pollock, $20 million for a Manet and $25 million
for a Warhol. Cohen also shelled out $8 million for Damien Hirst's
Physical Impossibility of Death in the Mind of Someone Living, a
14-foot tiger shark entombed in formaldehyde. ARTnews has named Cohen
one of the world's top ten art collectors for the third straight year.
Kenneth Griffin of Citadel Investment Group (No. 8 on our list, with
$240 million) made the ARTnews ranking for the first time last year,
after plunking down an undisclosed sum for a Cézanne still life,
Curtain, Jug and Fruit Bowl; it sold for $60.5 million in 1999. At
least eight hedge fund managers were among the magazine's 200 top art
collectors in 2004.
Of course, important art demands an appropriate showcase. Cohen is said
to be forking over $24 million for two apartments at One Beacon Court
in midtown Manhattan so that he can create a duplex pied-à-terre on the
upper floors. (His main residence is in Greenwich, Connecticut.) No
word yet on whether the shark is going up- or downstairs.
Collecting property can be almost as gratifying for hedge fund tycoons,
apparently, as buying paintings or large fish. "Hedge funds have had a
big effect on the real estate market," reports Barbara Corcoran,
chairwoman of New York–based real estate firm Corcoran Group. "The very
top tier has been changed by hedge funds."
To offer another example in the eight-digit domain (anything less is
ho-hum): York Capital Management's James Dinan (whose $125 million in
earnings place him No. 14 on our rich list) reportedly paid $21 million
for a Fifth Avenue co-op owned by former Tyco International chief
executive L. Dennis Kozlowski. And Caxton Associates' Bruce Kovner,
third on the rich list (with $550 million), is said to be spending well
upwards of $20 million to refurbish the 20,000-square-foot
Federal-style mansion he bought on New York's Fifth Avenue in 1999 for
$17.5 million.
Whatever cultural or social (or property) ambitions the top 25 hedge
fund managers may have, they landed on our list because they have been
superb investors over the long haul. But in a notable development, they
are no longer quite so reserved about it: Not content to look for
opportunities in today's lackluster markets, many are making things
happen through aggressive shareholder activism of a sort not witnessed
in more than two decades.
"Hedge funds are definitely flexing their muscles," declares George
Bason Jr., co-head of the merger practice at New York law firm Davis
Polk & Wardwell. Adds former Georgeson Shareholder Communications vice
chairman John Wilcox, who recently joined TIAA-CREF as head of
corporate governance, "It reminds me of the role arbitrageurs played in
the 1980s, when we had financially driven takeovers."
Hedge funds played pivotal, and well-publicized, roles in the ouster of
the head of Deutsche Börse and in the shake-up of the board at video
rental chain Blockbuster. The striking thing about this new hedge fund
activism is how pervasive, and how relentless, it has become.
Late last year Perry Capital's Richard Perry, No. 13 on the rich list
(with $153 million), engineered a complex and controversial transaction
involving his Perry Partners fund with the aim of ensuring that Mylan
Laboratories completed its purchase of King Pharmaceuticals, in which
Perry Partners had a sizable interest. Perry scooped up enough shares
of Mylan to be able to exert sway in the generic-drug maker's boardroom
as the company's largest shareholder. Simultaneously, however, he
shorted an equal amount of Mylan stock to hedge his bet. Despite all
this maneuvering, the Mylan-King merger — fiercely opposed by Mylan
shareholder and onetime corporate raider Carl Icahn — appeared to have
collapsed as of mid-May, because of accounting issues at King.
Nonetheless, Perry's ploy underscores the lengths to which hedge fund
managers will go to do deals.
In March, Beverly Enterprises agreed to put itself up for sale two
months after Appaloosa Management's David Tepper — who made $420
million last year, placing him at No. 5 on the rich list — and other
investors proposed to buy the nursing home company. The investors won
the right to participate in the auction of Beverly.
"I'd be lying to say I didn't look up to guys like Carl Icahn, T. Boone
Pickens, the Coniston Partners, Irwin Jacobs — people like that — as
corporate heroes," says one of the more activist hedge fund managers,
Daniel Loeb of Third Point (No. 20, with $110 million). "I was in my
early 20s, and these guys were coining serious money by buying
positions in undervalued companies and taking on entrenched management
head-on."
Perhaps the exemplar of the hedge fund activist writ large is ESL's
Lampert — the first to crack the $1 billion mark in our four-year-old
survey. Last year he orchestrated a merger between two of his holdings,
shopworn retailers Sears, Roebuck & Co. and Kmart Holding Corp.
Lampert's majority stake in Kmart, mostly bought while the company was
in bankruptcy, more than tripled in price last year. Meanwhile, his
Sears shares surged 12 percent. ESL racked up an estimated 69 percent
gross return.
Lampert was hardly the only hedge fund manager to break the bank
despite decidedly lackluster returns for hedge funds as a group.
(Consulting firm Hennessee Group calculates that the average hedge fund
was up just 8.3 percent last year.)
Quant guru James Simons of Renaissance Technologies Corp. made $670
million, putting him at No. 2 on the list. His Medallion fund rolled up
a 24.9 percent net gain. SAC Capital's Cohen managed 23 percent net.
Caxton's Kovner can't brag about his performance — his Caxton Global
Investments fund was up 9.9 percent in 2004 — but he has such a huge
personal stake in his funds from years of exceptional returns that he
still finished high up on the rich list.
On the whole, the biggest earners tended to do well both because they
had lots of their own capital in their funds and because they achieved
great performance. Others less wealthy (though hardly poor) benefited
principally from extraordinary gains. The best example: Tontine
Associates' Jeffrey Gendell, No. 12 on the rich list. His take was $180
million, mainly because his key fund rolled up a 101.4 percent net
return.
Still others of the top 25 collected huge sums despite so-so returns,
because they have so much capital in their funds. The single-digit
(net) set includes Kovner; Soros Fund Management's George Soros (No.
6), who made $305 million; and Highbridge Capital Management's Glenn
Dubin and Henry Swieca (tied at No. 18), each of whom earned $115
million.
Hedge fund managers, of course, cultivate secrecy almost as assiduously
as they do returns. But even those who have not set out to become
activists are collectively moving the markets. Consulting firm
Greenwich Associates found that in 2004 hedge funds accounted for 82
percent of trading in U.S. distressed debt and almost 30 percent of
trading in U.S. credit derivatives and sub-investment-grade bonds.
Cohen's $6 billion-in-assets SAC Capital is alone responsible for about
3 percent of the trading volume on the New York Stock Exchange.
Such clout may not be altogether a bad thing. Federal Reserve Board
chairman Alan Greenspan, for one, has said that "hedge funds have
become major contributors to the flexibility of the financial system —
a development that proved essential to our ability to absorb so many
economic shocks in recent years."
Yet even for excess-inured New Yorkers, the shock of hedge fund
managers' pay may take some getting used to.
1. $1.02 billion
Edward Lampert
ESL Investments
Attention, Sears shoppers: Eddie Lampert is in the house. More J.P.
Morgan than George Soros, the ESL Investments chief pulled off a daring
coup in March 2005 using his substantial stakes in Kmart Holding Corp.
and Sears, Roebuck & Co. to merge the two famed but fading retailers
into Sears Holdings Corp. At year-end his Kmart and Sears stakes
combined accounted for 63 percent of his $9.2 billion equity portfolio.
So far the bet has been nothing short of brilliant: Lampert's Kmart
shares — one of just a handful of stakes the value-oriented investor
holds — more than tripled in value last year, helping to lift his
overall portfolio by an estimated 69 percent, before his 1 percent
management fee and 20 percent performance fee. Some market observers
speculate that Lampert will use Sears' cash flow to do additional
deals.
Lampert held shares in just three companies other than Kmart for the
full year. The stocks rose modestly: Sears by 12 percent, AutoZone by 7
percent and AutoNation by nearly 5 percent. Lampert also did a little
pruning in 2004. Early on he sold a big chunk of Footstar at a 25
percent premium over its year-end 2003 price. In the first quarter of
2004, he also sold off his small stake in financial services company
Providian Financial Corp. for roughly 37 percent more than it traded
for at the end of 2003.
The 42-year-old Lampert, whose firm is based in Greenwich, Connecticut,
knows firsthand how elusive wealth and security can be. He grew up in
upscale Roslyn on New York's Long Island, but when he was 14, his
lawyer father died at 47. In January 2003, Lampert was kidnapped and
held for two days until he escaped. Lampert graduated summa cum laude
with a bachelor's degree in economics from Yale University, where he
was a member of Skull & Bones. He started as an arbitrageur under
former U.S. Treasury secretary Robert Rubin at Goldman, Sachs & Co.
Lampert left to start ESL in 1988, working out of the Fort Worth,
Texas, offices of investor Richard Rainwater, who staked Lampert with
$28 million. The two subsequently had a falling-out.
2. $670 million
James Simons
Renaissance Technologies Corp.
An award-winning geometrician, Jim Simons knows the angles like few
other investors. Last year his Medallion fund posted a return of 24.9
percent net of his stiff fees: 5 percent for management and 44 percent
of performance. That works out to a gross return of some 44 percent.
Since the fund's inception he has returned nearly 38 percent net to
investors (though in the early years, his fees were much lower). Simons
has long charged that 5 percent management fee, but as recently as
2001, his performance fee was 20 percent.
Helping to maintain those sky-high returns, Simons keeps a close grip
on the size of his fund, which is increasingly becoming a vehicle to
invest just the money of partners and employees. Last year Medallion
gave back all current income and 50 percent of the capital of
nonemployees. Another move toward becoming more closely held: The firm
recently removed its presence from the Web.
Simons uses sophisticated computer programs to trade rapidly and
frequently employs a lot of leverage. Regulatory filings show that
Renaissance had a $9.6 billion equity portfolio spread over 1,654
issues at the end of 2004, up from $8.5 billion at the end of the
previous quarter but well down from $15 billion at the end of the third
quarter of 2003. Simons' largest holdings at year-end 2004 were (in
order of size): Oracle Corp., Coca-Cola Co., Verizon Communications and
EBay.
Famed for eschewing traditional Wall Street types in favor of science
and math whizzes, East Setauket, New York–based Renaissance employs
some 60 individuals with Ph.D.s. Simons, 67, received his bachelor's
degree from the Massachusetts Institute of Technology and his Ph.D. in
mathematics from the University of California at Berkeley. A former
chairman of the mathematics department at the State University of New
York in Stony Brook who has taught math at MIT and Harvard University,
Simons wants to boost the math skills of both students and teachers. In
early 2004 he founded Math for America with other top mathematicians,
investment bankers and educators. Last November the group, which Simons
chairs, said it would contribute $25 million to establish the Newton
Fellowship Program, which will train 180 math teachers for New York
City public high schools over the next five years and give 40 to 45
math teachers stipends of $50,000 over four years for professional
development.
3. $550 million
Bruce Kovner
Caxton Associates
Though his firm's performance has improved, Bruce Kovner continues —
for him, anyway — to struggle. Last year's return of 9.93 percent
outdid the 8.10 percent for 2003 — Kovner's worst showing in a decade —
but remains far from the 30 percent annualized gains enjoyed over the
past 22 years by his flagship, $9.2 billion offshore fund, Caxton
Global Investments. Much of Caxton's 2004 return came in the fourth
quarter, when the fund's shares rose by 7.69 percent. In a letter to
investors, Caxton chief economist John Makin said that fourth-quarter
gains in currencies, stocks, commodities and non-U.S. financials
outweighed losses in energies and that U.S. financials underpinned the
fourth-quarter showing. The fund had a strong first-quarter 2004,
racking up a 4.6 percent increase on gains in commodities, energies,
stocks and financials, which overcame losses in currencies.
At the end of 2004, New York–based Caxton had a $3.4 billion equity
portfolio of 580 individual issues. The biggest position by far was a
$311 million stake in SPDRs, exchange-traded funds that mimic the
Standard & Poor's 500 index. His largest stock positions, in order:
Guidant Corp., Conseco, Mandalay Resort Group, Assurant and R.H.
Donnelley Corp. Kovner also simultaneously hedged a number of long
positions with puts in issues that included Chemed Corp.,
Cleveland-Cliffs, Kmart Holding Corp. and Time Warner.
A Harvard College grad, Kovner, 60, is founder and chairman of the
School Choice Scholarships Foundation, which provides scholarships for
low-income students from New York City to attend primary schools of
their choice. He is also chairman of the board of trustees of the
Juilliard School, chairman of the American Enterprise Institute and a
member of the boards of the New York Philharmonic and of the Thomas B.
Fordham Foundation, which promotes reform of elementary and secondary
schools. Kovner is also vice chairman of Lincoln Center for the
Performing Arts. A recent New York Times story estimated that Kovner is
spending between $20 million and $40 million to renovate his redbrick
Federal-style townhouse at Fifth Avenue and 94th Street, which had
housed the International Center of Photography. He bought it for $17.5
million in 1999.
4. $450 million
Steven Cohen
SAC Capital Advisors
Few, if any, people trade stocks as rapidly or aggressively — or
anywhere near as successfully — as Stevie Cohen, whose Stamford,
Connecticut–based SAC Capital Advisors regularly accounts for about 3
percent of the New York Stock Exchange's average daily volume. In 2004,
SAC, which manages some $6 billion, turned in another spectacular year
— a 23 percent average net return for its various funds. Given Cohen's
exceptionally high performance fees — he earns up to 50 percent of his
funds' returns on some funds — that translates into a roughly 40
percent gross return.
Cohen, 49, dramatically increased the size of his equity portfolio last
year, to $8.6 billion at year-end from $3.2 billion at the end of 2003.
His biggest positions in December 2004: cellular company Sprint Corp.,
utilities TXU Corp. and NRG Energy, medical-devices maker Stryker Corp.
and four different issues of IShares, which are exchange-traded funds.
He heavily hedged these positions with puts, including ones on IShares
and individual stocks, including American Pharmaceutical Partners, U.S.
Steel Corp. and Electronic Arts.
Like other hedge fund managers, Cohen has begun to play a more active
role in certain of his investments. In November, SAC provided $40
million in financing to embattled retailer Wet Seal in exchange for
convertible notes and warrants. The retailer subsequently removed its
chief executive, who had failed to turn around the ailing company, and
Wet Seal later became the subject of an informal Securities and
Exchange Commission probe into circumstances surrounding the delayed
filing of its second-quarter 2004 results. Cohen, a graduate of the
University of Pennsylvania's Wharton School, has also begun to amass
bigger, longer-term stakes of at least 5 percent in other chains,
including video rental companies Blockbuster and Movie Gallery and
health club operator Bally Total Fitness Holding Corp.
A celebrated art collector, Cohen has for the past three years been
named one of ARTnews magazine's top ten collectors. The New York Times
estimates that since 2000 he has spent more than $300 million building
a collection that includes works by Jackson Pollock, Édouard Manet,
Edgar Degas and Roy Lichtenstein. Cohen is also said to have plunked
down $8 million for Damien Hirst's 14-foot tiger shark submerged in a
tank of formaldehyde.
5. $420 million
David Tepper
Appaloosa Management
His returns can be as up-and-down as a painted pony on a carousel, but
David Tepper has been riding high of late: Last year he managed a
nearly 34 percent net return. Not too bad, except in comparison to
Tepper's otherworldly performance in 2003, when his two main funds —
Appaloosa Investment I and Palomino Funds — racked up nearly 150
percent returns net of his 1 percent management fee and 20 percent
performance fee, earning him some $510 million for the year.
Of his 42 percent gross gains in 2004, 23 percentage points' worth came
from plays in equities, particularly mining, coal, steel and copper and
other commodities stocks. His second- and third-biggest gains came from
positions in U.S. Steel Corp. and Peabody Energy Corp. His biggest
moneymaker: Enron Corp. bonds. Altogether, junk positions accounted for
14 percentage points of his returns.
Tepper, who ran $3.6 billion at year-end '04, has been more cautious of
late, moving 20 percent of his assets into cash. He gave $700 million
back to his investors at year-end. The 47-year-old, who started
Chatham, New Jersey–based Appaloosa in 1993 after heading junk bond
trading at Goldman, Sachs & Co., teamed up earlier this year with
Formation Capital, Franklin Mutual Advisers and Northbrook NBV to
launch a proxy fight against Beverly Enterprises, after the nursing
home operator rejected their $1.5 billion takeover bid. The investors —
Formation, Appaloosa, Franklin Mutual and Northbrook — agreed to back
off shortly before the April 21 annual meeting, when they reached an
agreement with Beverly to participate in an auction of the company.
Last year Tepper and his wife, Marlene, pledged $55 million to
Pittsburgh's Carnegie Mellon University School of Business, where he
received a master's degree in industrial administration in 1982. The
school was renamed the Tepper School of Business. The couple also gave
$27 million to the David Tepper Charitable Foundation, which donates
to, among other organizations, Care, Goodwill Rescue Mission and the
Salvation Army, according to data compiled by the Chronicle of
Philanthropy for Web magazine Slate.com.
John
day.
Name of Hedge Fund Group:
FANAM CAPITAL MANAGEMENT
SEC Information regarding hedge fund:
http://www.sec.gov/litigation/admin/ia-2316.htm
The Securities and Exchange Commission ("Commission") deems it
appropriate and in the public interest that public administrative and
cease-and-desist proceedings be, and hereby are, instituted pursuant to
Sections 203(e), 203(f), and 203(k) of the Investment Advisers Act of
1940 ("Advisers Act"), against Fanam Capital Management ("Fanam"),
Richard J. Ennis ("Ennis"), and Seth Morgulas ("Morgulas").
1. Fanam was organized on June 30, 2000 as a Nevada limited liability
company. Fanam was an unregistered investment adviser of a hedge fund
and its assets under management never exceeded $25 million. Ennis,
Morgulas, and Michael Beckford ("Beckford") were the Managing Members,
officers, and principal owners of Fanam. Fanam managed Fanam Fund I LLC
(the "Fund"). Fanam employed primarily three investment strategies for
the Fund: (1) Fanam sought to identify covered call opportunities; it
then bought stocks, held the positions for approximately one month, and
wrote short-term call options against these stocks; (2) Fanam bought
LEAP's, and wrote short-term call options against the LEAP's throughout
the life of the positions;2 and (3) Fanam developed a statistical
algorithm to identify temporarily mis-priced stocks that were likely to
revert to their statistical mean, and traded the stocks accordingly.
Fanam ceased operations, and now only exists as a corporate shell.
2. Ennis, age 37, is a resident of Pace, Florida. He was the President
and Chief Executive Officer of Fanam, and a Managing Member. He served
as Fanam's marketer and principal client contact. Ennis solicited the
majority of Fanam's third party investors, and issued periodic
statements and sent periodic performance updates to investors. Ennis
was also a Fanam investor who lost money as a result of Beckford's
fraud, and he contacted the criminal authorities after learning of
Beckford's fraud.
3. Morgulas, age 33, is a New York, New York resident. He was an
Executive Vice President, Portfolio Manager, and Managing Member of
Fanam. Morgulas' responsibilities included strategic planning, and
market strategy and analysis. In addition, Morgulas performed company
specific research, and directed Fanam's trading strategies, which were
executed by Beckford, Fanam's trader. Morgulas was also a Fanam
investor who lost money as a result of Beckford's fraud. Prior to
joining Fanam, Morgulas was a securities lawyer and financial research
analyst.
Other Relevant Persons or Entities
4. Beckford, age 35, is a Schaumburg, Illinois resident. He was an
Executive Vice President, Portfolio Manager, and Managing Member of
Fanam. Beckford was responsible for executing Fanam's trades, and for
managing Fanam's administrative operations, serving as both trader and
accountant. Beckford was the only Managing Member who communicated with
the initial clearing broker and Fanam's external accountant.
5. The Fund, was organized as a Delaware limited liability company on
October 11, 2000. The Fund had less than 100 investors and was
liquidated in June 2003.
Beckford's Fraud
6. Beckford gambled with investor money, traded outside of the Fund's
objectives, and paid himself money to which he was not entitled,
resulting in investor losses of $4,828,129.
7. Beckford started gambling with investor money in February 2001.
Beckford used the Fund's money for gambling activities in Lake Tahoe,
Las Vegas, and Henderson, Nevada, at horseracing tracks and off-track
betting parlors around the country, and on sporting events over the
internet. For example, on December 17, 2002, February 7, 2003, and
March 7, 2003, Beckford wired $150,000, $243,000, and $307,000,
respectively, to the Bellagio Hotel Casino in Las Vegas from Fanam's
brokerage account. Beckford lost the majority of the money sent to the
Bellagio by gambling at its casino and on its sports book, and he lost
some of the remaining money gambling at other casinos. Beckford also
used Fanam's money to finance his gambling trips. Investors paid for
Beckford's airfare, rental cars, and hotel rooms. In total, Beckford
lost $776,344 of investor money through his gambling losses and travel
expenses.
8. Beckford also failed to follow Fanam's stated trading objectives.
Beckford, among other things, held unhedged stocks, bought unhedged
LEAP's, and traded unhedged equity and index options. For example, in
February 2002, Beckford lost $46,500 in a single unhedged index option
trade. Later that month, Beckford bought large unhedged quantities of
March NASDAQ index puts for $126,000 and $392,000, respectively, and
these puts expired worthless. Beckford continued to increase the size
of his index option trades throughout 2002 to attempt to recoup Fanam's
losses. On December 6, 2002, Beckford bought $505,000 worth of NASDAQ
index calls, and these calls expired worthless. On January 14, 2003,
Beckford placed a larger bet on the next month of the same options
series for $1,976,000, and these calls also expired worthless. In
total, Beckford lost $3,876,775 trading outside of the Fund's
objectives.
9. Beckford also misappropriated investor funds for his personal use.
Beckford paid himself a monthly draw of approximately $5,000 from July
2001 through March 2003 and reimbursed himself for expenses. The
Managing Members agreed that Beckford could take a monthly advance
against his percentage of the 1.0% management fee and the 20% incentive
fee (the "Fees"). Because Fanam failed to make any money during this
time, Beckford was not entitled to a monthly draw or personal expense
reimbursements. In total, Beckford misappropriated $175,010 of Fanam's
money for his personal use.
10. Beckford issued false documents to Ennis, Morgulas, and Fanam's
investors to cover-up his fraudulent conduct. He prepared and sent
false spreadsheets to Ennis and Morgulas regarding Fanam's trading,
holdings, and performance. Beckford also forged auditor statements and
prepared false K-1's. He furnished copies of these documents to Ennis
and Morgulas, fully aware that Ennis would use these documents to
solicit investors. The returns Beckford listed in these documents did
not include his gambling losses, trading losses, and improper draws.
The investor statements issued to Fanam's investors, based on
Beckford's misrepresentations, stated that the Fund's annual returns
were approximately 25% to 30%. In reality, the Fund lost money during
the entire time it operated.
Morgulas' Failure to Supervise
11. Beckford was subject to Morgulas' supervision. Morgulas was
responsible for managing the Fund's positions, and he had the authority
to direct Beckford's trading to manage the Fund's portfolio. Morgulas
regularly communicated with Beckford regarding the Fund's portfolio.
Beckford was Fanam's sole trader, and managed Fanam's administrative
operations. Only Beckford communicated with Fanam's initial clearing
broker and external accountant. Morgulas never independently reviewed
Beckford's trading activity or independently confirmed the Fund's
positions or distributions. Morgulas never contacted the initial
clearing broker or the accountant to confirm the Fund's holdings.
Instead, Morgulas relied on spreadsheets supplied by Beckford to
monitor the trading, holdings, and performance of the Fund.
12. Morgulas failed reasonably to supervise Beckford with a view to
preventing violations of the federal securities laws. Morgulas failed
to take reasonable supervisory action, which could have included
maintaining accurate records of the Fund's transactions, reviewing
daily trading activity, valuing the Fund's positions, and separating
trading and administrative operations. Morgulas' reliance on Beckford's
spreadsheets, without independently verifying their accuracy, enabled
Beckford to continue his fraudulent activity.
Ennis Inflated Fanam's Assets Under Management
13. Unrelated to Beckford's fraud, from November 2001 through November
2002, Ennis overstated Fanam's assets under management to institutional
investors. In the Fall of 2001, Fanam entered into negotiations with an
international bank to manage certain holdings of the bank. Ennis and
representatives of this bank discussed Fanam managing $13 million to
$20 million of the bank's assets in an offshore account, but the money
never came into Fanam's account. Nevertheless, Ennis told investors
that Fanam managed $13 to $20 million in an offshore account. For
example in November 2001, Ennis told a potential institutional investor
that Fanam managed $13 million in an offshore account, and this
investor subsequently invested $800,000. On November 30, 2001, Fanam's
actual assets under management were only $139,565. In November 2002,
Ennis solicited a large "fund of funds" to invest with Fanam, and he
told this investor that Fanam had "total firm assets" of $25.25
million. The investor subsequently invested $8,000,000 with Fanam in
December 2002. On October 31, 2002 and November 29, 2002, Fanam's
actual "firm" assets under management were $1,282,112 and $1,545,945,
respectively.
Legal Findings
14. As a result of the conduct described above, Fanam willfully
violated Sections 206(1) and (2) of the Advisers Act, which prohibit an
investment adviser from employing any device, scheme, or artifice to
defraud or to engage in any transaction, practice, or course of
business, which operates as a fraud or deceit upon any client or
prospective client.
15. As a result of the conduct described above, Ennis willfully aided
and abetted and caused Fanam's violations of Sections 206(1) and 206(2)
of the Advisers Act by knowingly and substantially assisting Fanam in
employing any device, scheme, or artifice to defraud or to engage in
any transaction, practice, or course of business, which operates as a
fraud or deceit upon any client or prospective client by overstating
Fanam's assets under management.
16. As a result of the conduct described above, Morgulas failed to
reasonably supervise Beckford, with a view to preventing violations of
the federal securities laws while Beckford was subject to his
supervision, within the meaning of Section 203(e)(6) of the Advisers
Act. A person is a "supervisor" if, under the facts and circumstances
of a particular case, that person has the requisite degree of
responsibility, ability, or authority to affect the conduct of the
other individual whose behavior is at issue. In the Matter of John H.
Gutfreund, Thomas W. Strauss, and John W. Meriwether, Exchange Act Rel.
No. 31554, 51 S.E.C. Docket 93 (December 3, 1992). A supervisor with an
unregistered investment adviser has a duty to reasonably supervise
individuals subject to his supervision with a view towards preventing
violations of the federal securities laws. See Robert T. Littell and
Wilfred Meckel, Advisers Act Rel. No. 2203 (December 15, 2003).
John
Monthly Options Stats: May 2005 marketshare by exchange
May 2005 Equity Options Marketshare:
CBOE - 26.11%
AMEX - 15.70%
PHLX - 10.12%
PCX - 9.66%
ISE - 32.63%
BOX - 5.79%
May 2004 Equity Options Marketshare:
CBOE- 25.05%
AMEX -18.69%
PHLX - 12.00%
PCX - 8.60%
ISE - 34.03%
BOX - 1.28%
May 2005 Total Options Marketshare:
CBOE - 31.60%
AMEX - 14.92%
PHLX - 9.55%
PCX - 8.76%
ISE - 29.93%
BOX - 5.25%
May 2004 Total Options Marketshare:
CBOE - 31.16%
AMEX - 17.68%
PHLX - 11.44%
PCX - 7.78%
ISE - 30.78%
BOX - 1.16%
Michael Catolico
souls that bend over backwards to give you the best fills.
John wrote:
>May 2005 Total Options Marketshare:
>May 2004 Total Options Marketshare:
>
>
>
>
John
and smaller fees as performance declines because there are too few
investment opportunities and a shortage of talented fund managers.
According to Chicago-based Hedge Fund Research, the amount invested in
hedge funds has climbed to more than $1 trillion from $640 billion two
years ago, while the number of funds increased to 7,904 from 5,329,
leaving too many fund managers chasing too few investment
opportunities. New hedge fund investments either slowed or declined in
the first quarter. A Hedge Fund Research report said the amount of new
money invested in the quarter increased by just 23% compared with more
than 180% in the year-earlier period, while a report by Tremont Capital
Management found investing declined by $13 billion in the quarter.
HF rapid growth puts fund managers off short positions
Reuters reports, according to a new survey by hedge fund consultants
Hennessee Group, a rapid growth of hedge fund numbers and assets is
making it more difficult for fund managers to borrow stocks to short
them. However, according to Charles Gradante, the group's managing
director, the growth in hedge funds doesn’t appear to be posing a
systemic risk to the financial system through the use of leverage,
which caused the 1998 collapse of Long-Term Capital Management. The
annual survey, which took data from 752 hedge funds representing over
$238 billion in assets, found that funds are increasingly reliant on
derivatives, such as futures and options, to balance their long
positions. But such instruments can be expensive and thus can cut into.
According to Hennessee, hedging strategies have generated annualized
returns of 14.94% with 40% less volatility since 1987 than the S&P 500,
which returned 11.88% over the same period including dividend
reinvestment.
John
The World According to Marty O’Connell
Although statistics are hard to come by, it’s likely that nobody has
taught more people about options than Marty O’Connell. Since 1977,
thousands of exchange locals, over-the-counter traders and hedgers have
passed through the Chicago offices of O’Connell & Piper Associates.
O’Connell was a market-maker on the Chicago Board Options Exchange from
1977 until 1984, before branching out into managed futures accounts,
management consulting and seminars. He spoke with editor Joe Kolman in
August.
Derivatives Strategy: How did you get started in the options business?
Marty O’Connell: I got my start in 1977 as an independent market-maker
on the Chicago Board Options Exchange. What attracted me to the options
business more than anything was the mathematics of it. I liked the
Black-Scholes model and was more comfortable with it than I should have
been at the time. On the other hand, after I was in the business for no
more than a couple of months, it occurred to me that there was
something else going on in addition to the math. Option-trading brings
out certain kinds of behavior—mostly human weakness rather than
strength. Over the years, that’s been even more fascinating to me than
the math.
DS: Why do people seem to make so many mistakes with options?
MO: The options business is mostly about managing three dimensions of
exposure: There is usually some exposure to the underlying price, to
the passage of time and to changes in implied volatility. In other
words, if I have an option position, my P&L will probably have a lot to
do with changes in these variables—individually and in combinations.
The rest of the complexity comes from the fact that my P&L will almost
always respond in a nonlinear way to each of these variables. On top of
that, there often are other minor dimensions of exposure associated
with a particular commodity and a particular situation. Most of the
trouble people get into with options comes from a lack of appreciation
for the multidimensional, nonlinear character of the products—or from
an attempt to avoid it.
DS: They want to simplify, and that’s where they get into trouble?
MO: Sometimes they try to construct a situation in which they get the
benefits of the multidimensional, nonlinear nature of options without
the problems that come with it.
DS: Do you have an example?
MO: Sure. People may simply focus on one variable and imagine that
that’s where the action is going to be. A dealer, for instance, might
want to bet on a change in implied volatility, because he thinks
implied volatility is going higher or lower, or because he thinks there
is going to be some shift in the implied volatility curve, and he wants
his P&L to reflect the correctness of his view. But in many cases, the
position’s P&L will respond to the change in implied volatility in a
nonlinear way. Also, he may have to live with the fact that the
underlying price movements or time decay might have more of an effect
on his P&L than the accuracy of his view of implied volatility. In
other words, he might want to bet on a change in implied volatility,
but most of his P&L might depend on the actual volatility of the
underlying.
Another oversimplification is the over-reliance on Greek letters for
the risk management of options. This isn’t to say that the Greeks
aren’t useful tools. Of course they are, but there are two problems.
One is that they focus only on one variable at a time. Delta and gamma
are measures of an exposure to underlying price movements, assuming
none of the other variables is going to change. Theta and vega serve
similar roles with respect to changes in time and implied volatility.
Each of these Greeks offers a one-dimensional view of a
three-dimensional puzzle. What’s more, a Greek letter considers only
incremental effects—it doesn’t show your exposure to a discrete change
in any of the variables. In the real world, instead of a small change
in a variable we often wind up with a big change, perhaps in more than
one variable. And the Greeks don’t even begin to address those
exposures.
I’ve done a lot of trading in my life. I’ve had winners and losers, and
every once in a while I’ve gotten beaten up. When I’ve lost a lot of
money trading options, it was never because of an incremental change in
anything. It always happened because there was a big change in the
underlying price, time, implied volatility or some combination of those
things.
DS: You are careful to distinguish between the effects of actual
volatility and the effects of changes in implied volatility. Are
traders often confused by these dynamics?
MO: It is amazing how often traders—even experienced traders—get hurt
by sloppy thinking about volatility. For example, in January 1991 we
were coming up to the Gulf War. You might recall that U.N. forces
weren’t going to start bombing Iraq until at least January 15. As we
got closer and closer to that date, financial instruments moved around
a little bit but implied volatility kept getting higher and higher,
because traders thought that as soon as the bombs dropped—or didn’t
drop—there would be a lot of movement in financial commodity prices.
When the bombs finally dropped, we did get significant volatility. Some
financial instruments moved a lot, but the options’ implied
volatilities collapsed rather quickly. Some people who thought they
were betting on high actual volatility were really more exposed to
implied volatility. They were right on one count and wrong on the
other—and in most cases, they lost money.
DS: In your seminars, you talk quite a bit about people looking for
magical option positions.
MO: Yes, that’s a common mistake. A lot of people want to find a
position that allows them to have their cake and eat it too. Among
dealers or neutral options speculators, they tend to be addicted
premium buyers or sellers. They might think, “If I’m only long options,
then all the big moves will be in my favor and everything is going to
be great.” Or if they’re premium sellers, they think, “If I’m only
short options, the options will decay and this is the right position.”
A speculative trader might say, “I want to find a profit opportunity
that has no real risk to it or one where the risks don’t matter.”
“When I’ve lost a lot of money trading options, it was never because of
an incremental change in anything. It always happened because there was
a big change in underlying price, time, implied volatility or some
combination of those things.”
>From a hedger’s point of view, it’s a little different. It usually
means, “I would like to hedge my position, but I don’t want there to be
any cost and I don’t want to give up my profit potential.” In the 1980s
and early 1990s, the magical position for hedgers tended to be some
kind of zero-premium position. Because hedgers don’t like to write
checks for option positions, the magical position often turns out to be
a collar or a participating forward or any other of a wide variety of
zero-premium positions. Sometimes, these are called “zero cost”
positions. Eventually, naive hedgers get an expensive lesson in the
nature of opportunity costs.
But the fact of the matter is that there are no magical positions out
there. Every position has some good and bad in it, and any position can
be a good idea or a bad idea, depending on the circumstances.
Another way people look for options magic is by trying to use options
to make the past untrue. I have often run into market-makers who have
problems and want to talk about them. A common problem is, “I put on
this position, and I know I shouldn’t have been that short. It started
to go against me and I should have adjusted, but I didn’t—and now I am
really in trouble.” What they really want to know is, How can I do an
option trade to make none of this true anymore?
You see the same thing in corporate hedging. A corporate hedger has an
asset or liability that he should have hedged but didn’t, or one he
should have hedged more thoroughly. The trade then went against him,
and now he is looking around for a way to make the past untrue.
DS: It’s just avoiding taking losses?
MO: In some cases that’s true, but I’ve heard people say, “It’s my
responsibility to get this back.” That can be scary, because they might
take a lot of risk to give themselves a chance to make everything OK.
DS: I think that’s what Nick Leeson said.
MO: I wouldn’t be surprised.
DS: What other common mistakes do you see in options trading?
MO: We often see people draw inappropriate conclusions from short-term
results. Too many managers excessively punish or reward individual
traders based on short-term P&Ls. But in the options business, like so
many businesses, there are a lot of random ups and downs. If you are
too quick to jump all over your traders when they lose money and too
quick to turn them into heroes when they make money, your traders are
going to think up positions that have high probabilities of winning.
But in a nonlinear, multidimensional business, a position that has a
high probability of winning may or may not be a good position.
DS: It may be exposing you to a huge tail risk.
MO: That’s one possibility. The problem could be a remote event that
would be disastrous for your organization. Or the problem could be the
average result. You could simply be exposing yourself to a position
that might win most of the time, but will lose over the long term. It’s
easy to think up positions that are going to win 70 percent, 80 percent
or 90 percent of the time, only to find that the large losses
inevitably eat up all those small wins.
DS: Could you give me an example?
MO: Back in the mid-1980s, most major commercial banks were getting
into the foreign exchange and interest rate options business. To
attract them as clients, brokers wanted to recommend a winning trade.
Many recommended strangle-selling, in which you sell an
out-of-the-money call and an out-of-the-money put—and very likely
collect the premiums on both sides.
If the calls and the puts are priced richly enough, and if the
underlying commodity isn’t likely to be too volatile, the trade might
actually be a good idea. But if you sell the strangle too cheaply,
ultimately the approach is going to be a loser. And if you do it in big
size, you will ultimately get hurt, because there will be an occasional
huge loss to go with all your small wins. But these kinds of trades can
seem quite attractive, even if they’re not particularly good. If you’ve
forgotten that remote events happen, they can even seem like options
magic.
DS: So the head of a trading desk relying on short-term results is not
measuring the risk his traders have taken on fairly or accurately
enough.
MO: Exactly. He’s doing two things. First, he is measuring the quality
of the trade simply by the frequency of profits, or by the likelihood
of making profits—not by the average profit over time. Second, he is
measuring the risk only in terms of everyday events and not in terms of
remote events. Of course, in the 1990s, value-at-risk foolishness has
lured a lot of organizations into feeling safe while ignoring remote
risks.
DS: Of course, you can also make mistakes by ignoring short-term
results.
MO: Sure. You hear a lot of rationalizations such as “This trade didn’t
work out, but if I keep doing it, it will work out.” Sometimes that’s
true, and sometimes not. You can’t ignore short-term results, but on
the other hand, you can’t assume that short-term results validate a
strategy.
“In a nonlinear, multidimensional business, a position that has a high
probability of winning may or may not be a good position.”
Within a large organization, a big part of the problem can be that
managers don’t want to have to learn the options business. They don’t
want to manage the process. They just want to manage the results.
That’s not good enough. Short-term results don’t convey enough
information. Managers need to be coaches.
DS: I don’t suppose the trap of focusing on short-term results is
limited to brokers and managers.
MO: No. Traders do it all the time. Maybe they always have. In 1975,
when I began thinking about becoming an options trader, I spent some
time on the CBOE floor to see if I could learn something. It was
largely a premium selling community. A lot of traders thought the idea
was to sell calls that were a couple of strike prices out of the money
and that had only a few weeks to go. They thought that during the last
month before expiration, a stock wasn’t going to run through more than
one strike price. When you asked them why they were so sure that was
true, the answer would often be, “I tried it through three expirations
in a row and made money every time.”
My old partner, Jim Piper, used to talk about “the permanent present
tense.” That refers to the way traders use the present tense when the
past tense or future tense would be more useful. For example, you will
hear traders say, “Buying premium is what works now,” or “Selling
premium is what works now.” What that means is, “This strategy has been
working lately, so it’s what I’m doing for the future.” The present
tense conveys a fantasy of stability and predictability. It also allows
them to think it isn’t their fault if they lose money.
DS: What other weaknesses are traders likely to have?
MO: O’Connell & Piper used to have a client in Chicago—a smart
market-maker—who was good at hiring traders. He said there are two
things that are difficult to find in a trader. The most difficult thing
to find is a trader who can take a big loss and not have it upset him
to the point that he changes his behavior. The second most difficult
thing to find is a trader whose perspective is not affected by an
unusually large gain.
DS: It’s like in any business or undertaking. If you have a failure,
you think that something needs to be changed. If you have a success,
you think you know why. But that might not be the case.
MO: Right. What’s different in our business is that it all happens
faster. If you make money building hotels, the same formula might work
for years. Then, you might find it doesn’t work for a while, and it
might be some time before it makes sense to build hotels again. If
you’re smart or lucky, you’ll change your behavior at just the right
time. If conditions don’t change too often, you won’t really know
whether you were smart or lucky—or dumb or unlucky. But we deal in much
shorter cycles, and that’s why our weaknesses are so visible in our
behavior.
DS: Any other common options fallacies that come to mind?
MO: The fantasy of continuous markets. Often dealers and others will
trade as if they will always have a chance to get out. An assumption of
most models is that markets are going to be continuous. That’s usually
true enough, but every once in a while markets are not continuous and
people are severely hurt.
A related fantasy is excessive confidence in stop orders. Traders will
put on negative-gamma positions. These are positions that get shorter
as the underlying price goes up and get longer as the underlying price
goes down. Traders will try to defend the position with stop orders. Of
course, stop orders work until they don’t work anymore. Most of the
time, stop orders get filled easily. But sometimes they don’t get done
at anywhere near the price you expected. You see this often in foreign
exchange, but also in commodities. People will leave overnight stop
orders and wind up getting terrible fills because the markets were
illiquid when their stop limit got hit.
DS: We’ve talked a lot about speculative traders, but you’ve also done
a lot of work with corporate hedgers. Do you have any advice for them?
MO: Hedgers focus too much on expiration characteristics. Corporate
hedgers or institutional investor hedgers draw expiration graphs and
think they understand them, so they put on positions and let them sit
until expiration. Of course, when you draw an expiration graph, one of
the things you have to ask yourself is, How sure are you that you won’t
touch this position? Because if there is a reasonable chance that you
are going to touch the position before expiration, the expiration graph
won’t matter because your P&L profile will look different.
You often see somebody draw an expiration graph and say, “This is great
except for this one little piece of the graph over here where I’ve got
a problem, but if it goes that way I’ll make an adjustment.” So once
again, the whole expiration graph doesn’t mean much. Even in 1999, we
still see hedgers looking at expiration graphs for positions with
barrier options. They’re really kidding themselves.
“You still hear people say, ‘We don’t like the kind of size one of our
traders does, but what can we do about it? He’s making money.’”
A related problem is the tendency to leave a position untouched until
expiration. An initial position in an option hedge is usually based on
views on the direction or volatility of the underlying price or on
changes in implied volatility. The nonlinear, multidimensional
characteristics of the position should reflect these views as well as
some considerations of risk tolerance. But over the life of the
position, it’s almost certain that some of these views or
characteristics are going to change. And if these things have changed,
then the hedger probably doesn’t have the best hedge or even an
appropriate hedge anymore. The simplicity and comfort of focusing on
the expiration characteristics can be easy, but for many hedgers it’s
time to move to a more sophisticated approach.
DS: There’s been a lot of talk about improving the risk management of
traders in the past few years, but based on your comments we haven’t
come too far.
MO: Our computers have advanced faster than human nature. Although most
big trading firms these days have large, sophisticated risk management
operations, you still hear people say, “We don’t like the kind of size
one of our traders does, but what can we do about it? He’s making
money.” You still see situations in which traders commit risk
violations and the manager overlooks them because the position made
money. Those managers have a lot of nerve cashing their paychecks.
John
Andrew Lo is the Harris & Harris Group Professor of Finance at MIT's
Sloan School of Management and the director of MIT's Laboratory for
Financial Engineering. He has spent most of his academic career
developing models of financial markets as well as developing
computational algorithms for implementing those models. He is a
coauthor of The Econometrics of Financial Markets, a popular
graduate-level textbook on the statistical methods most useful for
financial engineering. Most recently, he published A Non-Random Walk
Down Wall Street with A. Craig MacKinlay (Princeton University Press,
1999), which examines some of the major market anomalies of the last
three decades. He spoke with editor Joe Kolman in January.
Derivatives Strategy: You've done a lot of work on detecting
predictable components in the stock market and the implications for
derivatives pricing. What have you discovered?
Andrew Lo: In 1988, Craig MacKinlay and I started thinking about the
random walk hypothesis. We wanted to construct a more robust test of
the random walk, a test that would be able to detect departures—even
small departures—from randomness. When we constructed this test and
applied it to U.S. stock returns, we found some dramatic violations of
the random walk. At first, we thought we must have made a programming
error.
DS: You found inefficiencies in the market that were dramatic.
AL: I wouldn't call them inefficiencies. An inefficiency implies that
somehow people are being irrational or stupid, or that there is
something wrong with the market. Quite to the contrary, what we
discovered was a “market opportunity” rather than a market
inefficiency. It's not as if individuals were being lazy or irrational,
but rather that there was predictability in the marketplace that might
have been created by changes in supply and demand, or by some kind of
demand for liquidity. By trading in certain ways, and therefore by
providing liquidity to the marketplace, one could earn a pretty
handsome return.
This was in the late 1980s, and D.E. Shaw had just been created.
Although Craig and I didn't know it at the time, Shaw's main focus was
to take advantage of these patterns.
DS: How would you describe these particular patterns?
AL: They were rather stark. On a weekly basis, there seemed to be a
significant amount of positive correlation from one week to the next.
That is, if the market return was high one week, it tended to be high
the next week as well. And if it was low one week, it tended to be low
the next week. So there was a certain amount of persistence in weekly
stock index returns.
The curious thing was that when you looked at individual stock returns
such as IBM or Microsoft, there was little in the way of
predictability. This puzzled us for a long time. In fact, it was one of
the reasons we felt we had made a programming error. When you looked at
portfolio returns, you got sharp rejections of the random walk, but
when you looked at individual securities, it seemed like the random
walk was a pretty good fit. It wasn't until we started teasing apart
some of our statistics that we realized what was going on.
“There was a certain amount of persistence in weekly stock index
returns, but when you looked at individual stock returns, there was
little in the way of predictability. This puzzled us for a long time.”
The predictability came largely from cross-stocks/cross-week
correlations. In other words, if you look at stock A this week and
next, there's not a lot of correlation between those two returns. If
you look at stock B this week and next, there's not a lot of
correlation between those two returns. But it turns out that there
actually is a significant correlation between stock A this week and
stock B next week. It was these cross effects that were giving us the
rejections of the random walk hypothesis.
Right around that time, again unbeknownst to us, a trading strategy
called “pairs trading” was becoming popular among equity traders. They
would trade pairs of securities, one long and the other short, to take
advantage of certain pricing anomalies. Many traders engaged in these
kinds of activities, including D.E. Shaw.
DS: And LTCM...
AL: I believe they were doing similar types of trades in the
fixed-income markets. We had inadvertently stumbled upon a set of
trades that people had also come upon through entirely different means.
Interestingly enough, over the past 10 years, since we published our
paper, the kind of predictabilities that we first discovered have
become considerably less significant.
DS: They've been arbitraged away.
AL: Yes, quite a lot has been arbitraged away, but not all of it. There
are still some aspects that are present. So this is not to say that you
can't continue doing it. Obviously, D.E. Shaw is quite successful with
its equity portfolio. The firm has lost money on its fixed-income
trades, of course.
DS: What specific trade would a trader do to take advantage of this
opportunity?
AL: Well, if a trader discovered that stock A and stock B were
positively correlated across weeks, then he or she would use stock A
this week to forecast stock B next week. An example of a trading
strategy that benefits from such cross-week predictabilities is a
contrarian strategy where you buy the losers and sell the winners.
Contrarians think that prices overreact—that what goes up must come
down and vice versa—so buying the losers and selling the winners can be
profitable. But the existence of cross-week predictabilities provides
another source of contrarian profits. To see this, consider a stock
market with only two stocks, A and B, and let A and B have positive
cross-week correlations. Suppose A is up this week and B is down; a
contrarian would then sell A and buy B. But when there's positive
cross-week correlation, an up-week for A implies an up-week for B next
week, and a down-week for B implies a down-week for A next week, hence
a contrarian profits from both positions—but it's because of these
cross-stock predictabilities, not overreaction. If you are trading 150
stocks simultaneously, it's much more complicated to take into account
all of these possible cross effects—there are some real combinatorial
challenges involved. That's what D.E. Shaw does so successfully: it
uses various computational algorithms to optimize these sorts of
trades. Nowadays, there are many more sophisticated varieties.
DS: What are the implications of this phenomenon for derivatives
pricing?
AL: My colleague Jiang Wang and I wrote a paper four years ago that
made what we thought was a rather simple and uncontroversial point. In
derivatives pricing models, the expected return of the underlying
security does not enter into the formula of the derivatives price.
DS: The important thing in the Black-Scholes-Merton model is
volatility.
AL: That's right. But while it's true that volatility may be the only
thing that matters in the formula, from an empirical point of view the
expected return of the underlying asset certainly affects the
volatility.
DS: It's an indirect influence.
AL: Exactly. I'll give you a simple example. Suppose we can perfectly
predict what next week's stock price is going to be. In that case,
what's the volatility? It's zero—there is no volatility. That's an
example of an indirect relationship between knowing the expected return
and having a handle on the volatility.
DS: Of course, we couldn't possibly know the expected return.
AL: That's right. But what if we could know a little bit about it? The
Black-Scholes-Merton formula and most derivatives pricing models assume
you can't predict returns at all. They assume that returns are what we
academics call “independently and identically distributed,” or IID. If
you assume that returns are IID, then the only thing that matters for
derivatives pricing is the volatility.
But what if they're not IID? What if you know something about next
week's return? For example, what if you've got five factors that tell
you a lot about the behavior of Microsoft. It turns out that the
existence of such predictability is going to influence the volatility.
The more predictability there is, the less volatility there's going to
be.
I gave you an example of an extreme case, in which there's perfect
predictability and therefore no volatility. But you don't have to look
at such an extreme. Even if there's a little bit of predictability, it
will tend to reduce the volatility.
DS: I suppose you're taking this discovery you and others made about
correlation and setting it up as a kind of subcomponent of the
Black-Scholes-Merton model.
AL: Yes, but we also did it more generally for other kinds of
derivatives pricing formulas. Let's say you can explain next week's
returns to a small degree using factors from this week. And the measure
of predictability is R2. That's a common statistical measure. If the R2
of a simple regression equation is 100 percent, then you've explained
it perfectly. If it's 0, you haven't explained it at all. And if it's
anywhere in between, you've got some predictability. What we found was
that even if you had, say, 10 percent predictability in next week's
returns, that could have fairly dramatic implications for derivatives
prices.
DS: How dramatic?
AL: It will affect prices by 20 percent, and in some cases 30 percent,
for even modest levels of predictability. That seems to suggest that
this is an important feature. What we don't know is whether people have
fully incorporated this into their models. We suspect that some have.
Maybe D.E. Shaw, maybe Salomon Smith Barney, maybe JP Morgan or some of
the more advanced derivatives houses. But since we don't do much
consulting in that area, we don't really have a handle on what people
in the industry are doing with it.
“While volatility may be the only thing that matters in the
[Black-Scholes-Merton] formula, the expected return of the underlying
asset certainly affects the volatility.”
DS: Have you ever thought of altering the Black-Scholes-Merton model in
some way or coming up with a new version on your own?
AL: We have. In the paper Wang and I published, we have a derivative
pricing formula that adjusts the Black-Scholes-Merton formula for
predictability.
DS: But how likely is perfect predictability?
AL: We argue in our paper that you'll never get perfect predictability.
That's one of the most beautiful aspects of financial markets. In some
sense, arbitrage provides you with an upper boundary on how much
predictability there can ever be in securities markets. Having said
that, there is still some predictability—it's not zero. That's what
Craig MacKinlay and I found in our research, and we've spent 10 years
and written 12 research papers documenting this fact in a number of
different ways.
DS: So the arbitrage opportunities you talked about have diminished.
What does that say about the random walk hypothesis in general?
AL: It says that the random walk hypothesis is an approximation of
reality and that the approximation errors increase and decrease through
time. In the 1980s, the approximation error was rather large. The
random walk was actually a pretty poor approximation of the way stock
indexes behaved. Over the last 10 years, the approximation has improved
because there have been arbitrageurs out there taking advantage of
these errors.
DS: Exceedingly sophisticated arbitrageurs who are fulfilling their
function in the market.
AL: Let me suggest something I find even more interesting that is
happening today. I haven't done an exhaustive study, but I have done
some casual empirical analysis. My sense is that over the past couple
of years, the approximation is breaking down yet again. It looks like
there are new kinds of predictabilities coming into play. I think
that's because there are a lot of unsophisticated investors entering
the market, thanks to this raging bull market.
DS: Every experienced professional investor has been infuriated by the
ability of completely ignorant investors to make a lot of money on
Internet stocks.
“Over the past couple years, there are new kinds of predictabilities
coming into play because there are a lot of unsophisticated investors
coming into the market.”
AL: Nobody understands how these Internet stocks are behaving, but
they're going up, and there are certain predictable patterns. And
individuals who are not as technologically sophisticated are getting
involved. If you go to the Amazon.com web site and click on the 10
best-selling books for 1998, you'll find the usual suspects: Tom
Clancy, Stephen King and Tom Wolfe. But you'll also find that one of
the top–10 best-selling books of 1998 is “The Electronic Day Trader.”
What this tells me is that there's a new element in the market now. In
the past, there were two different groups of investors: passive
investors and active investors. Now, there is a new group: hyperactive
investors.
DS: Maybe you'd call them the tulip bulb investors.
AL: I must say I'm tempted to do that because I think many individuals
are trading on very little information. They're trading on emotion, and
that's the easiest way to do a lot of damage to a portfolio. But with
that kind of activity going on, is it any wonder there are new forms of
predictability being created in the marketplace? And, as a result, new
opportunities that are presented to sophisticated arbitrageurs like
D.E. Shaw?
DS: You've also done quite a bit of research on risk preferences.
AL: I just published a paper in the Financial Analyst's Journal titled
“The Three P's of Total Risk Management.” The point I make in that
paper is that we've got a lot of sophisticated tools for calculating
value-at-risk and doing scenario analysis and so on. But those are not
the most important aspects of risk management.
Any complete risk management system really contains three components:
prices, probabilities and preferences. You have to know about
prices—How much does it cost to hedge a certain risk? You have to know
about probabilities—that's VAR. But even if you know those two
quantities perfectly, without any estimation error, that still leaves
open the question of how much risk you should hedge.
How is a CFO going to figure out how much foreign currency risk to
hedge? From an end-user's perspective, VAR doesn't give you the answer.
DS: Quite often people decide to hedge 60 percent or 50 percent or some
other number based on their own criteria.
AL: But what is the right number? How do we know it's 50 percent and
not 43 percent? Or 85 percent? I argue that a single answer doesn't
exist. The answer depends on individual and corporate preferences for
risk.
DS: How much pain they're willing to suffer.
AL: Exactly.
DS: Which gets us back to value-at-risk, doesn't it?
AL: No, because VAR does not tell you how much pain you're willing to
suffer. It will tell you the likelihood of suffering a certain amount
of pain. It will tell you with 95 percent probability that you will
suffer at most a $100 million loss over the next month.
DS: But you can suffer more.
AL: You can suffer more—or less. More specifically, you can change the
dial on your risk meter. You can adjust the VAR so it's not $100
million, but $50 million. Or maybe $150 million.
For example, the reason that LTCM increased the risk of its portfolio
after returning money to investors was because it was actually bearing
much less risk than it wanted. People there show an extremely
compelling series of statistics in which the portfolio's standard
deviation was quite a bit lower than that of the S&P500, which is about
what it wanted the standard deviation to be.
The bottom-line question for risk management is, “How much risk do you
want to bear?” We really have not focused on that question yet, and you
can't do proper risk management until you answer it. In my research,
I'm beginning to explore the psychological aspects of risk bearing to
understand how people determine their own risk tolerances.
DS: Are you trying to quantify preferences in some way?
AL: Yes, exactly. It involves conducting psychological surveys and
having people fill out risk-attitude questionnaires. It involves giving
people choices between several lotteries, or several trading
strategies, and getting them to pick which trading strategy is more
valuable or less valuable. By asking a sequence of these lottery-type
questions, you can construct a mathematical representation of their
risk tolerances.
DS: It seems to me that the answers are going to be somewhat
irrational.
AL: I think in many cases it's not a matter of irrationality but simply
risk preferences. Interestingly enough, if you explain to people what
their preferences are, in some cases they might actually change them.
I'm not really sure what that means. Does that mean they were
irrational before? Maybe it means that people change their preferences
over time.
Some of my colleagues have expressed a bit of surprise and dismay that
I am going down this track. My response is, “What else am I supposed to
do? I've been led here by my research. Where else am I supposed to look
for the answers to the questions I want answered?”
John
Eating Volatility For Breakfast
One day in the life of Mike Riley, Amex options specialist
By Barclay T. Leib
8:45 A.M.
Mike Riley, senior New York partner for Letco Specialists LP, is
sitting in his Trinity Place offices chatting about the day to come.
“Don’t let anyone tell you that this job doesn’t come with a great deal
of stress,” says Riley, a big burly guy with the freckled face of a
redhead. “When I get down to the floor, I am totally focused. But if I
lose my focus, I can lose a lot of money. This business has also not
been without a physical toll.”
Although not quite in his 50s, Riley has suffered two heart attacks,
one of which also involved a mild stroke, and has been carried off the
trading floor on a stretcher on two occasions. Put a stethoscope to his
chest and you’ll hear the steady tick of a pacemaker.
Letco makes markets in 105 stocks assigned to it by the American Stock
Exchange. Under AMEX rules, Riley is obligated to offer a price in
every option in all market environments, making sure that customer
orders are filled at prices competitive with those available on other
exchanges. Somehow, in the midst of these efforts, he must make money
for himself, while ensuring that the market-makers who compete with him
have access to the same customer orders.
Riley is by nature a skeptical bear making money off of a bull market.
Today, he will be directly watching seven stocks, and will actively
trade in four high-flying tech stocks with annual volatility in excess
of 50 percent—Applied Materials, Nextel, Xilinx and Foundry Networks.
“The way these stocks trade,” he says, “for all I know, they’re all
worth nothing.” But Riley is less concerned with the absolute direction
of prices than he is with the pace of their movement.
Earlier this morning (it’s a balmy late May day), Riley spent 20
minutes in a meeting with his colleagues, where they labeled many of
the firm’s stocks “stable” or “unstable.” Letco is holding positions on
several thousand option contracts in total—most of which were taken on
after a customer dealt on a price the firm was obligated to show. Riley
and his colleagues are always discussing how to structure the firm’s
options book—what option positions they’d like to have—knowing full
well that there’s often an unbridgeable chasm between what they want
and what the market may actually give them.
9:15 A.M.
We march through the Members Only entrance to the American Stock
Exchange. Stocks have been plunging for two months straight, but in
yesterday’s session the Dow jumped 240 points and the Nasdaq 100 was up
over 8 percent. Will this turn into a significant reversal? Riley has
no particular view, but says today could be an important test of the
market’s ongoing ability to rally. Riley stands at Post 21 in a corner
of the AMEX Red Room—a cave-like basement adjacent to the exchange’s
main building. The low stucco ceilings are crowded with computer
screens, and the air-conditioning system blasts away incessantly in the
background.
He slides behind a long countertop. There is no stool or bench. A
series of computer screens flash information upward from under a panel
of Plexiglas, and a row of flat-paneled screens labeled XTOPS and AODB
sit on top. Across the counter, a line of market-makers are standing in
front of him in a similar row, each with a portable electronic trading
slate. One fellow is playing Solitaire on his machine, another is
intently checking rows of numbers. Tucked behind Riley is a Bloomberg
terminal that his firm uses to keep abreast of news, relative trading
volume in options and an intraday chart that he occasionally glances
at.
“So where are we?” Riley barks to his assistant, Sean.
“Nextel’s still up $7,” replies Sean. “Looks like Xilinx is coming in
firmer. AMAT is soft at $85. Foundry’s unchanged.”
The volatility of Riley’s four active stocks would give the most
experienced trader a bad case of the willies. Over the past year,
Nextel Communications has ranged from $36 to $160 before descending
into the $80s. (It has since split two for one.) The stock moves almost
twice as much as the Dow, sporting an implied volatility of around 85
percent. Xilinx’s volatility is just marginally lower at approximately
74 percent, the stock having ranged from $22 to $88 a share in the past
year. Meanwhile, Applied Materials, with the symbol AMAT, has become
one of the hottest of the hot semiconductor stocks in the past year,
rising from $30 to $115 before suffering a significant reversal to $85.
Riley will continue massaging his XTOPS system right up to the day’s
close, jiggling his volatility curves higher and lower as he sees the
flow. If he guesses wrong on a volatility level or skew, he could find
himself obligated to trade at a disadvantageous price, or potentially
arbitraged against a different exchange.
None of these stocks, however, even comes close to Foundry Networks,
which has dropped from a high of $208 in March to $75 today, with a
front-month volatility of 110 percent. “That one is a real piece of
work,” explains Riley. “It flies around on very little volume, often
trading on less than a third of the shares the others do.”
This kind of volatility is commonplace in his trading neighborhood. The
Letco partner directly to his right is making option markets in
Priceline.com. The next one down is covering Yahoo.
Riley quickly checks the flat-paneled XTOPS screen, the heart and soul
of his market-making. The XTOPS system allows him to build and assign
an appropriate options-pricing volatility curve and enter other
variables, such as the cost of money and stock short-selling rebates,
in order to price thousands of different strike prices.
Riley will be tapping volatility levels into this machine all day: 95
percent for the front-month Xilinx options, 80 percent for the next
series out, 65 percent for the longer-dated options. He will also be
adjusting out-of-the-money options higher and lower to reflect the
volatility skew he expects. Once his volatility parameters are set, the
machine calculates the actual dollar prices of the options in real time
as the underlying stock moves.
But Riley’s market-making parameters are not set in stone, of course. A
little like a pinball junkie, Riley will continue massaging his XTOPS
system right up to the day’s close, jiggling his volatility curves
higher and lower as he sees the flow. If he guesses wrong on a
volatility level or skew, he could find himself obligated to trade at a
disadvantageous price, or potentially arbitraged against a different
exchange. If the system freezes—even for a few seconds—his trading will
have to stop.
XTOPS is also much more than just a simple pricing tool. The system
helps him manage the second-most-important machine on his desk—the AODB
(Automatic Order Data Base), the actual electronic order book for each
option series. After XTOPS generates all of the specialist’s
bid-offered prices and transmits them electronically to the world, it
automatically matches these prices against the bids and offers that
appear on the AODB terminal.
>From the AODB terminal orders stream directly into the XTOPS machine.
If a bid and offer are close enough to warrant attention, the stock
turns from green to yellow. “Yellow means pay attention,” explains
Riley. “Something is close to being tradable.”
When a stock flashes to yellow, Riley will quickly move to a
full-screen view of that stock’s options, find the specific strike and
maturity that is potentially executable (also now color-coded yellow)
and tell Sean, his assistant, what he wants to do. Generally, he will
also query the trading crowd in front of him as to whether they want to
participate in the trade.
It’s now the opening at 9:30 A.M., and his first yellow-coded trigger
of the day pops up on the screen. One hundred and thirty June AMAT 85
puts are offered at 4 1/8. His theoretical valuation curve within XTOPS
tells him that he should buy some of these options at that price.
“Spec buys 50 June 85 AMAT puts at 4 1/8,” he announces. “There’s
another 80 offered there, do you guys want ’em?”
Out in the crowd, four 20-something market-makers—one each from Timber
Hill, Susquehanna and GPZ, plus an independent trader—look up from
their terminals. They all raise their hands like schoolchildren with
the correct answer to a math question.
“Fine, 80 more trade 4 1/8—20, 20, 20, 20,” Riley barks, as assistant
Sean goes into the electronic order book to effect the execution.
A few short keystrokes later, and Sean announces, “AMAT waterfall.” The
trades print on a large electronic screen in back of him, allowing the
individual market-makers to verify what they each have done. There will
be refrains of “waterfall” from the specialist clerks all day as trades
are completed. The trades also migrate electronically to the
market-makers’ hand-held screens and to the specialist’s XTOPS machine.
The XTOPS screen also amalgamates small trades of one and two contracts
that have been automatically executed by the AMEX’s Auto-Ex System.
Small pink slips of paper representing these trades are available to be
examined just behind Riley, but he will not do so. The trades simply
filter into his book without human intervention.
“There’s another 80 offered there, do you guys want ’em?” Out in the
crowd, four 20-something market makers—one each from Timber Hill,
Susquehanna and GPZ, plus an independent trader, look up from their
terminals. They all raise their hands like schoolchildren with the
correct answer to a math question.
Every option position held by the specialist, whether he knows about it
explicitly or not, is then multiplied behind the scenes by its
real-time delta and combined into a “net synthetic stock position” that
appears just under the name of the stock on the screen. If this total
position starts to become too negative or positive, either from new
trades or a change in the price of the underlying stock, Riley will
look to buy or sell stock to adjust it. His goal is not only to buy
options on his bid and sell others on his offer, but to trade the
underlying stock adroitly to rebalance his position constantly.
Notably, XTOPS’ synthetic calculation does not include Riley’s
underlying equity positions, which he watches independently. Every few
minutes he will ask Sean for “a new stock count” in a given equity. So
while XTOPS shows Riley that he is long 86,000 shares of Applied
Materials, he is actually close to flat once he factors in his short
equity position. Riley does this calculation in his head all day long.
9:31 A.M.
Riley must now pay attention to all of the other option strikes and
maturities for AMAT as well as each of the six other stocks that he is
directly responsible for. What other option bids or offers coming
through from the AODB machine need to be filled?
Within the first minute of trading he will clear all of the other
yellow-coded situations. He announces seven or eight further trades in
five different stocks, then turns to hover over Sean’s shoulder to look
at all the incoming new orders.
“Book, book, book, spec, allocate everybody,” he reels off, looking
down the list and comparing the new orders to the current market for
each option already on the screen.
“Book” means the option is not currently executable and is to join the
rest of the orders on the electronic order book. “Spec” means that he
is taking the other side of the new order—filling it from his own
position. “Allocate everybody” means that each of the market-makers in
the crowd is getting part of an executable order, whether or not they
know it yet. Riley is like a maestro making the trading flow just as
the orchestral band leader helps make the music come forth.
To an outsider, some of his decisions may seem arbitrary, but for every
snap decision he makes, he must keep upstairs customers happy by making
sure his prices are competitive with those at other exchanges. At the
same time, he has to make sure that the crowd of market-makers standing
in front are not unhappy. It is a fine balancing act that he has
clearly mastered.
In the first few minutes of trading, AMAT has jumped from $85 to $86
1/2. It is not clear whether Riley ever had time to buy a stock hedge
against the AMAT puts he bought on the opening.
A Merrill broker in a striped jacket approaches for a price. “AMAT June
95 puts?” he queries. A few toggles of the XTOPS system, and Riley
announces, “10 5/8–11.”
“I have 500 to go, 10 5/8.”
“You sell 200 to me, PRO 809M [Riley’s floor badge number], you guys
want the balance?” Riley queries. The market-makers’ hands all go up
again. “Fine. 500 trade total, 300 out there, how much each? 50? 80?
120. 40.” The market-makers exchange further details with the Merrill
broker, while Riley turns to yet a third terminal to his right—an
Instinet DOT machine—to check the underlying stock. AMAT is suddenly
falling, now trading down to $84.
“That guy came in just at the wrong time,” says Riley with a bit of
glee. “Look at where the stock is now. I’d pay 11 5/8 for those options
now.” He is quickly entering buy orders for his delta hedge against
both of his first put deals. Once he has finished clicking away at the
DOT machine, he turns to Sean and says, “Get me a stock count on AMAT
when you have a chance.” Riley wants to confirm his total exposure to
AMAT and he can only do that if he knows exactly how much stock he has
positioned.
10:15 A.M.
“Holy shit,” says Riley. “Xilinx is flying. AMAT is collapsing. Foundry
is up huge. These stocks are all over the place. That’s how I know
they’re all worth nothing. Sean, I need a stock count, Foundries. Does
anyone know what that Pru broker is trying to do? I think he may be
sniffing around to sell those Foundry calls he bought yesterday. Can we
call their booth?”
“Holy shit,” says Riley. “Xilinx is flying. AMAT is collapsing. Foundry
is up huge. These stocks are all over the place. That’s how I know
they’re all worth nothing. Sean, I need a stock count, Foundries. Does
anyone know what that Pru broker is trying to do? I think he may be
sniffing around to sell those Foundry calls he bought yesterday. Can we
call their booth?”
Riley is thinking primarily about Foundry for the moment, but must
shift gears instantaneously when his assistant spots a large market
order coming into Xilinx on the electronic book.
“Mike, I’ve got 100 Sep 75 Xilinx puts for sale here,” Sean announces,
looking down at a market order on the AODB screen.
“I pay $6,” snaps Riley.
The trade prints, and the XTOPS machine immediately flashes back a new
quote, 6 3/8–6/5/8. Riley has snagged a nice purchase: the stock is now
dropping.
A few hours later, this trade will come back to haunt Riley when a
floor official comes by to query his fill. At the time Riley bought
these options at $6, the Pacific Coast Exchange was apparently showing
a 6 1/8 bid and the upstairs customer wants a fill no worse than 6
1/8th. Riley will protest a bit, but eventually agrees to adjust the
fill to the higher level. In his haste, he may have missed checking the
bid-offered prices of the other exchanges.
This situation highlights one awkward aspect of multiple-listed option
contracts. Although other exchanges’ bid and offered prices always show
up on the consolidated pricing screens, if Riley actually wants to send
an order to another exchange for execution, or trade against that
exchange for his own account, he must telephone in the order. There is
no direct electronic connection—a small, time-consuming kink in an
otherwise automated world.
11:00 A.M.
A broker-dealer comes in and sells Riley 100 December ’01 calls on
Nextel. “He may know something is going on, and back-dated options are
dangerous,” says Riley. “I’m going to push my back-dated volatilities
down a bit.” His fingers madly push at various toggle adjustments on
the XTOPS system. December ’01 Nextel option prices are suddenly all
1/8 to 1/4 lower than they were a few seconds ago.
Relaxing for just a moment between trades, Riley explains that
longer-dated options are the most difficult for specialists on the
floor to price. The principal risk every specialist worries about is a
takeover, and the longer an option’s maturity, the greater this risk is
magnified.
“Nextel’s been a takeover target off and on,” explains Riley. “If it
ever gets taken over for cash, all the time-value we might pay for
longer-dated options can simply go up in smoke. But because of its
large capitalization, it’s more likely a takeover candidate for stock.”
What Riley is really pricing, therefore, are the odds of Nextel being
taken over in the next two years by another stock that has listed
options on it. “If a takeover did take place, we’d likely end up with
options on the new stock, but there is a tremendous amount of
difference if this new stock is a Vodafone or a Bell South. Vodafone
can trade at a volatility in the 80s, but the other is almost always in
the 50s,” Riley explains.
So how does Riley make the price on a two-year option on Nextel? He
walks me through his thought process: “Front-month volatility on the
stock itself is trading around 90 percent, and its long-term mean
volatility is probably worth 65 percent. But with maybe a 10 percent
chance of a takeover for cash, and a 40 percent chance of a takeover
for stock only worth 50 percent volatility, two-year Nextel options
that currently trade at 57 percent volatility really aren’t that
cheap.”
Riley admits there is no definitive answer here. He thinks of his job
as more of an art than a science, so he tends to keep his back-dated
positions as modest as possible. “If I take too big of a position in
longer dates, it’s easy to drop a few hundred thousand dollars simply
by getting unlucky,” he says. “There is a lot of risk we take all day
long that is not particularly quantifiable. You can still get screwed
even with good risk management.”
11:30 A.M.
>From its 10:15 A.M. low at $84, AMAT has now vaulted up yet again to
$87. Riley has been paid on calls on the way up, but strategically
over-hedges himself by buying extra stock. He then gets synthetically
short when—with the stock trading $86—someone sells him puts that he
chooses not to hedge.
When the stock scoots up to $87 1/2, he curses lightly and says he
wants the stock back down. “If it keeps going up, my long gamma will
take me out of my short position,” he offers, “but it’s still a real
loss, not just an opportunity cost.” In other words, Riley is long
enough underlying options on AMAT that they will eventually act as a
stop-loss to his decision not to hedge his newly purchased puts. But it
will be the equivalent of hedging at a less advantageous price.
Riley explains that other things being equal, he likes trading from a
long gamma, short vega position when possible. The long gamma helps him
do an able job market-making with less risk to sudden fluctuations in
the underlying stock prices, while the short vega in longer-dated
options helps avoid the takeover risk syndrome he worries about.
“Right now, as a shop, we’re running with a total negative time decay
of about $230,000 a day,” he explains. “AMAT by itself is costing about
$15,000 a day, Nextel $10,000, Xilinx $5,000. I’ve easily covered all
that theta already today in our delta hedges, even though I haven’t
been trading the market particularly well.”
“Are you always positioned this way—long of front-end options?” I ask.
Some traders and clerks nearby giggle at my question.
“Not that long ago, I was short 70,000 shares of gamma per point
movement in the underlying of AMAT,” says Riley. “I was collecting
$600,000 in theta a day at the peak. People on the desk thought I was
nuts. But it was right into AMAT’s earnings announcement and I was just
getting paid in volatility on everything at pretty lofty levels.”
Then Riley recalls that AMAT’s earnings came in about as expected, but
the stock dropped anyway, from around $83 to $75 in the after-market.
“We were selling all the way down—we had to,” says Riley. “But we still
ended up pretty synthetically long down at that lower level—even after
all of our sales. It was not a night when I went home and slept
particularly well. But by the opening the next morning, the stock was
back up to unchanged and vols collapsed. We actually ended up doing
quite well.”
12:30 P.M.
A noticeable lunch-time lull has arrived together with a few sandwiches
and sodas. Per Riley’s wish, AMAT has lurched lower from its $87 1/2
high back to $83 1/4, but has now found a midday equilibrium toward $85
1/2. Nextel has dropped from up $7 on the day to down $3 before
recovering to unchanged. In the last half-hour, Riley has profitably
legged into more delta hedges in both stocks.
But the incoming orders on the AODB machine suddenly drop off to a
trickle. The yellow-coded signals on XTOPS stop arriving, and are
replaced instead by a steady green.
Nature calls. Riley heads for his single trip of the day to the men’s
room.
2:15 P.M.
AMAT is back to $87 1/2, and rumors are swinging through the floor that
somebody is buying Intel calls like crazy.
He takes a long breath and then announces: “2,000 July 115 calls trade
at 2 3/8...500 me PRO, the rest out there...400, 40, 400, 160, 500.” He
somehow magically knows what each market-maker is good for. Is this
competition? Or is this a group of people following the direction of
the specialist acting as their pied piper?
Suddenly, a broker comes in looking at the bid in July 115 AMAT calls
for size—2,000 contracts. Two hundred contracts is considered a
large-sized order; 2,000 contracts is clearly so big that it’s being
generated by an institution many times the size of Letco Specialists.
To make matters more difficult, the broker announces that his customer
is also checking the market for these options “away” at the Chicago
Board Options Exchange.
Riley shows a 2 1/4 bid, a few of the other market-makers grunting in
assent. The broker offers them at 2 3/8. There is a long pause as Riley
contemplates whether this option trade is doable or not. If he doesn’t
step up to the plate, he may lose the business to Chicago. If he fills
the client on the option, but then misses getting a good fill on his
stock hedge, he can easily turn this trade into a money-loser for his
firm. He quietly clicks out a sell of stock on the Instinet DOT. The
market-makers are all clearly going to defer to his lead—his
orchestration as to whether this option prints or not.
He takes a long breath and then announces: “2,000 July 115 calls trade
at 2 3/8...500 me PRO, the rest out there...400, 40, 400, 160, 500.” He
somehow magically knows what each market-maker is good for. Is this
competition? Or is this a group of people following the direction of
the specialist acting as their pied piper? It is hard to tell, but the
trade gets done and all are happy. The business has not been lost to
another trading floor.
3:30 P.M.
Riley takes a break to discuss problems Letco has had dealing with the
Internet frenzy and the trading patterns he has witnessed.
“Back in 1999 the mere announcement of a stock split would bring in
huge call option buy orders,” explains Riley. “It was stupid but
meaningful at the same time. Once we had 500 orders piled up on that
order book machine all looking to buy. Vol went from 25 to 50 and
remained there for a number of days. We had to sell a lot of options we
were not immediately able to cover. After that, we started pricing for
possible stock splits adding skew to the upside...”
Suddenly Riley is interrupted by his Letco colleague to the left, who
trades Texaco and wants some quick advice.
“Hey Mike, Texaco is up $3. Stevie here from Timber Hill wants a price
on the July $60 calls. What do you wanna make?”
“4 5/8—7/8” says Riley studying his XTOPS machine.
“I could sell 400 there,” Steve, the Timber Hill market-maker,
responds.
“Done,” says Riley as both he and his fellow partner inadvertently
duplicate a stock hedge on their respective Instinet DOT machines.
There is momentary pause as they figure out what they have done. Then
the Timber Hill guy pipes up and says he could sell another 200.
“Done,” the Letco Specialists offer in relief. Their previous
over-hedge has now proved fortuitous.
Soon afterward, a headline hits Bloomberg: “NYSE order imbalance to
sell Texaco at the close.” That means that for some reason there are
market-on-close sell orders building up over on the Big Board. Through
its announcement, the NYSE is making people aware of this fact and
trying to elicit some interest from potential buyers. The stock
immediately drops a point and Riley and his partner sport big smiles.
They now have a bit more gamma from their new option purchases to trade
against.
The Internet stock circus plays on. AMAT is now getting hit, trading
down to $84 1/4, then $83 3/8. In a heartbeat, Foundry networks drops
from $87 to $83. Xilinx is falling into the close as well. Riley starts
madly buying stock in all three.
3:58 P.M.
I’ve been standing all day. My legs are tired. I look over at Rob, the
lone independent market-maker. The close is just two minutes away, but
he doesn’t look busy.
“Do you have a particular style of trading?” I ask.
“I used to be a short option seller,” he answers, “But I saw the light.
Look at this goddamn stock Texaco,” he points out. “Up $4 a few minutes
ago, now only up a buck and change. It took 1.6 million shares to get
it up there; and now we’re down 2 1/2 points from the high on just
250,000 shares. That specialist should be in jail.”
“Easy, Rob,” says Riley in defense of the Texaco specialist on the NYSE
who he likely does not even know. “I think the market has more to do
with it than the specialist. Don’t badmouth our brethren. We love you
too, Rob.”
“You’re hiding it well,” Rob retorts.
Has Rob lost money for the day? Or is this just gentle banter between
options market-making friends? Again, it’s hard to tell. Turning back
to address me, Rob chastises himself. “No brains up here,” he says
pointing to his cranium. “The only other job I’m qualified for—or ever
held—is delivering Chinese food.”
4:01 P.M.
Somewhere in the next room, a bell is ringing: the end of the trading
day. Riley freezes his trading system before any after-market stock
quotes start to wreak havoc with his carefully designed option-pricing
grid. AMAT’s range for the day has been $83 1/16 to $87 3/4, mild by
current-day standards. Nextel has traded between $89 1/8 and $96 3/4, a
tad more volatile but nothing outside the norms for Riley and
associates.
Riley and all his teammates exchange a ceremonial fist touch to
congratulate their hard work together. Some of Riley’s partners head
home. Within minutes, the floor empties far faster than would seem
humanly possible.
About 90 percent of Riley’s business that day has been completed
electronically. Riley’s job as a specialist dates back to the days of
ledgers and paper order books, but there are none of these anymore.
Instead, Riley has stood captain over his XTOPS pricing tool and his
Instinet DOT terminal, while the AODB machine has quietly interfaced
with the former. In time, it is easy to imagine Riley interfacing with
a fourth screen connected to the International Securities Exchange, the
new on-line options exchange. For the moment, though, AMEX rules allow
this only to occur upstairs, off the exchange floor.
Riley is painfully aware that many people think specialists on the
floor of an exchange have a “license to steal”—and that his job is
viewed as antiquated, noncompetitive and unnecessary. Some even suggest
that his function won’t exist in a few years, completely replaced by
new technology. But on this day at least, Riley appears to have worked
quite hard—using modern technology as opposed to resisting it.
“How’d you do today?” I query.
“Traded like a baboon,” says Riley, “But all considering, we did just
fine.”
Dirty Tricks in Internet Options
Are options used to manipulate the price of Internet stocks? From his
position on the front lines, Mike Riley sees a lot of suspicious
trading patterns. Some might be worthy of fueling an SEC
investigation—or two.
In one situation, Riley was trading options on Yahoo during a
particularly volatile expiration day in late 1999. In the morning,
Yahoo had quickly moved up $7 dollars to trade around $183. By 3:30
P.M., the stock had reached $186. But with 15 minutes to go to the
close, the stock was still well under $190—a level where a strike price
existed with considerable open interest.
“Then, with just a few minutes to trade, a big retail customer came in
looking for the 190 calls,” says Riley. Examining the AODB machine,
Riley saw that Chicago was offering these options at just 7/8th while
he was actually bidding $1, an inverted market—but who knew what this
option was worth, if anything, with just a few minutes to trade? Riley
called Chicago to try to lift their offer, and, just to be competitive
with the rival exchange, agreed to sell the customer 200 of the options
at 7/8th—a trade he was not exactly thrilled about but felt obligated
to transact given his specialist duties.
“We finally got Chicago up to $1 bid,” Riley retells, “and then the
customer plows in and buys 2,000 up to $2, then another 1,000 up to $2
1/2, and then the last 1,000 on both exchanges at $5.” Everyone was
scrambling to buy stock at the same time, and the stock shot up to 190
1/2 by the close.
Of course, Riley could have made money on the trade—if he had been able
to buy a sufficient number of Yahoo shares at some reasonable price.
But, he explains, “We couldn’t buy any stock—hardly a single share. The
stock traded up to $194 1/2 in the after-market on no size and opened
$199 on Monday, before vaulting up to $206. We got run over, as I’m
sure the CBOE did too. That two-minute bet ended up costing us over $1
million.”
Was the retail customer trying to manipulate the stock using options?
In that specific instance, Riley isn’t sure what that trade
represented. But it did make for a pretty wild expiration day with some
fairly odd trading behavior.
Another questionable incident involved trading in Priceline options.
Exchanges cannot begin trading options until 90 days after a stock’s
initial public offering. In the spring of 1999, the AMEX was preparing
to start options trading on Priceline on the 91st day, and had assigned
Letco to manage it.
“I should have seen it coming quicker,” Riley looks back. “We had
requests for Flex customized options before we even started trading the
standardized options. That should have been the tip-off that insiders
were selling. The stock fell $15 before I realized what was going on,
but it’s clear now that insiders were huge buyers of puts and sellers
of calls.”
Riley does not know what Priceline.com insiders were legally allowed to
do, given lock-up covenants, but he is adamant that “they somehow found
an outlet to hedge their stock holdings using options.”
“Within a month’s time, I’d estimate that 10 million shares were
synthetically sold using options,” he says. “Of course the skew to puts
was incredible, and it was next to impossible to borrow the stock. The
whole thing continued that way for the longest time until the secondary
stock offering at $67. Then the stock became easier to borrow and the
vols normalized somewhat.”
Riley has even stronger questions about potential insider trading he
witnessed in Summit Technology shortly before a May takeover
announcement. “Two days before that takeover hit the news services, one
broker came plowing in wanting to do a most unusual spread
trade—selling the June 12 puts and buying the in-the-money June 10
calls. The entire package had something like a 160 percent delta. Then,
boom, the takeover is announced two days later. Now tell me that
customer didn’t know something.”
Letco reported the odd trading to the authorities, but Riley doubts if
the SEC will do anything about it. “It’s just another complaint from a
group of people—the specialists—whose existence the government is not
sure they even want to acknowledge. No one really cares when we get
picked off.”
John
Lottery millionaire seeks billionaire status
Thursday, June 16, 2005 Posted: 9:35 AM EDT (1335 GMT)
Brad Duke hopes to leverage his lottery winnings to create a $1 billion
portfolio.
BOISE, Idaho (AP) -- A man who won a $220.3 million Powerball lottery
jackpot -- the second-largest single-ticket Powerball winning -- plans
to invest the money and become a billionaire.
Brad Duke, a 33-year-old regional fitness director for a health club
chain, said he hopes to build a $1 billion portfolio within 15 years.
"What better opportunity to have than me at my age with this money to
build a billion-dollar empire to take care of my family and to give
opportunities to the people who have given me opportunities," he told
The Associated Press on Wednesday.
Duke chose to take a one-time payment of $125.3 million, rather than 30
annual installments of $7.4 million. He would receive about $85 million
after taxes.
Idaho Lottery Commission officials denied Duke's request to remain
anonymous, arguing that his name had to be made public to show he had
no ties to lottery employees or vendors. He won the jackpot over
Memorial Day weekend.
"It would have been nice for me to take care of my family without
making it a big thing in their lives, but we all came to the
realization that would be impossible, so if that's the way it's going
to be let's have fun with it," he said before traveling to New York
City for talk show appearances.
Duke said he told his father and sister about the jackpot but the rest
of his family was unaware until Sunday, when he asked them to meet him
in Sun Valley. He said they had assumed he was going to reveal a
terminal illness, multilevel marketing scheme or a wedding engagement.
Duke has assembled legal, financial and public relations advisers to
make business investments and charity donations and is considering
appearances on a reality television program.
Other than a high-end racing bicycle, Duke has no plans for any large
purchases.
"One of my goals is keeping my feet on the ground, not forgetting who I
am and where I came from and staying active in the things I like now,
like biking, the fitness industry, camping and rafting with my
friends," he said. "Keeping my feet on the ground does not include
going out and buying a yacht."
Powerball is a Des Moines, Iowa-based lottery played in 27 states, the
District of Columbia and the Virgin Islands. Duke bought the winning
ticket at a Boise convenience store.
Gabriel Alindogan
support his family on his $30M /year salary with the Timberwolves.
I love their multi millionaires who want to grow to billions to take care of
their family
John
Convertible arbitrage specialist sees few opportunities
By Alistair Barr, MarketWatch
SAN FRANCISCO (MarketWatch) -- Marin Capital Partners, a hedge fund
that once oversaw about $2 billion in assets, is shutting down because
the firm sees few opportunities in the convertible arbitrage and credit
arbitrage strategies it follows.
Marin, which has moved most of its investments into cash, will stop
trading at the end of June and return money to investors in early July,
according to a letter the firm sent to investors this week.
"Due to a lack of suitable investment opportunities in the current
market environment, and in our view an unfavorable risk/ reward
situation in the relative value strategies we trade, Marin has moved
the fund's portfolio largely into cash," Marin said in its letter, a
copy of which was obtained by MarketWatch.
"Because we do not expect the opportunities to return in the near
future, we have decided to return all capital to our investors," the
San Rafael, Calif.-based firm added in the letter.
Anton Nicholas, a spokesman for the firm, confirmed Marin's intention
to close on Wednesday but declined to comment further.
Marin is the most high-profile hedge fund casualty of the funk in
convertible bond markets.
Convertible bonds pay a fixed yield like traditional corporate debt,
but also let investors swap their note for stock of the issuing company
at a predetermined price.
More than 70% of trading in this market is by hedge funds that seek to
exploit the spreads between the price of convertibles and their
underlying stock, according to a Credit Suisse First Boston estimate in
March.
This overcrowding has left too many managers chasing a limited number
of trading ideas, denting returns.
It's also left many investors itching to dump their
convertible-arbitrage hedge funds -- to the tune of $2.8 billion in
this year's first quarter alone, according to data from Tremont Capital
Management.
Redemptions have forced some convertible hedge funds to sell positions
in order to return money. That process has fueled further declines in
convertible bond prices.
Convertible arbitrage managers lost an average 1.55% in May, after
shedding 3.13% in April, according to Tremont.
A convertible arbitrage fund run by Greenwich, Conn.-based FrontPoint
Partners has lost more than 18% in the first five months of 2005.
The FrontPoint Convertible Arbitrage Fund has seen its assets wane from
more than $100 million in 2004 to less than $85 million at the end of
May.
A FrontPoint spokesman declined to comment.
Marin, founded in 1999 by John Hull and J.T. Hansen, said it was proud
of its record, citing the performance of its flagship Tiburon Fund
which had returned more than 98% with relatively low volatility since
inception, according to the firm's letter.
While some hedge-fund industry observers have been predicting a
recovery by convertible arbitrage managers, Marin's decision suggests
any rebound may take longer to emerge.
"Without conviction that there will be near term opportunities to
generate sufficient returns on your behalf using appropriately hedged
strategies, it is only prudent to make the decision to close the fund,"
the firm said in its letter.
Alistair Barr is a reporter for MarketWatch in San Francisco.
John
Bloomberg reports, SAC Capital Advisors LLC, the $6 billion hedge fund
company run by Steven A. Cohen, may allow investors put money in its
funds for the first time since the firm opened in 1992. Cohen’s funds
have risen at an average annual rate of about 40% before fees since his
firm started trading. Cohen charges clients as much as 50% of profits
for some of his funds, compared with an industry average of 20%. He
earned about $450 million last year, thus becoming the world’s fourth
best-paid hedge fund manager, according to estimates by Institutional
Investor’s Alpha magazine.
Pirate
will require taking extreme risks that could lead to being a W2er
again..... what the hell does he want to buy with 1 bill that he cant
with 85 mil? - talk about greed....
John
of his family. And clearly if you want to do that in today's world,
you are going to need a billion dollars. Do you know what it cost to
go to a Cubs game these days!
John
blowing up left and right this year.
13/06/2005 Julius Baer to launch convertible & high-yield hedge fund
Reuters reports, Julius Baer Investments Ltd will launch a hedge fund
in July to trade convertible bonds and high-yield debt as it considers
them are attractive profit opportunities in the sectors. The JB
Convertible and High Yield Hedge Fund will launch on July 1 and focus
on securities rated BB or below and they will be hedged with credit
protection, outright shorts, equity and interest rate positions. Julius
Baer expects the fund to launch with about $120 million and will use
leverage of up to four times assets. The estimated initial capacity of
the fund is about $500 million. The fund will be listed in Dublin,
domiciled in the Cayman Islands and its prime broker will be U.S.
investment bank Citigroup.
17/06/2005 Duet Asset Mgmt to launch 3rd convertible fund
HedgeFund.Net reports, London-based firm Duet Asset Management with
$500 million under management, is preparing to launch a convertible
fund on July 1st. This will be the firm’s third fund and will be
launched at $25 million under the guidance of manager Dave Moore, who
joined Duet in April after establishing a convertible fund with
Jeffries & Co. in 2002 and who has a background in convertible bond
trading. Duet Convertible Fund has a $250,000 minimum investment, a 2%
management fee and a 20% performance fee.
Cedrick Johnson
-c
--
"But when you're passionate you can do anything."
Michael Milken
John
Mom nabbed in hedge fund scam
Jun 17, 2005
By Martin B. Cassidy
Staff Writer
Published June 17 2005
NEW HAVEN -- The mother of the 21-year-old New York University student
already jailed on bank fraud charges was arrested yesterday morning and
both were charged with wire fraud after wealthy investors put $7.4
million in a hedge fund prosecutors say didn't exist.
Ayferafet Yalincak, 50, of Pound Ridge, N.Y., and her son, Hakan
Yalincak, 21, pleaded not guilty in separate appearances yesterday
afternoon in U.S. District Court in New Haven. Both were charged with
single counts of conspiracy to commit wire fraud and three counts of
wire fraud.
Hakan Yalincak has been held at the Donald E. Wyatt Detention Center in
Central Falls, R.I., since early May on a count of bank fraud after he
attempted to deposit $43 million in checks at banks in Greenwich and
Switzerland in March.
If convicted on wire fraud counts, both face possible 65-year prison
sentences and fines of up to $1 million. In addition, Hakan Yalincak
faces a maximum 30-year prison term and a fine of up to $1 million on
the bank fraud charge.
A teary-eyed Ayferafet Yalin-cak exhaled loudly as a federal marshal
re-shackled her at the end of the hearing. Waiting to be led from the
courtroom and transferred to York Correctional Institute in Niantic,
she beat a rolled up copy of the indictment against her legs.
According to the indictment, Ayferafet Yalincak and her son played the
part of wealthy investors and entrepreneurs, promising their marks that
their money was earning large returns under Hakan's deft financial
management and providing fake investment account statements and other
materials to support their claims. Both used multiple names, with
Ayferafet Yalincak going by Jackie Yalincak and Irene Kelly, while her
son called himself John Sahenk.
Ayferafet Yalincak rented office space at 112 Mason St., while Hakan
Yalincak had an office at 283 Greenwich Ave. They claimed to represent
a number of businesses, including Yasam Trading LLC, Daedalus Capital
Partners LLC and Greenwich Special Fi-nancing I LLC, according to court
records. Together, they got seven people to invest $7.4 million, the
indictment said.
In one instance, Hakan Yalincak produced a false bank statement
purportedly issued by Smith Barney CitiGroup to convince two clients
that their money was earning healthy returns.
Ayferafet Yalincak fooled another investor by giving him a New York
University newsletter that said her family was giving a $21 million
endowment to the school, according to court documents. That convinced
the investor that the seemingly wealthy Yalincaks would be willing to
put $20 million of their own money in the fund, the documents said.
In fact, the Yalincaks did promise $21 million to the university, even
though they have a record of bad credit and debt. To cover the first
$1.25 million installment on the endowment, Hakan Yalincak transferred
$1 million from a Morgan Stanley account in the name of one of his
business fronts, Greenwich Special Financing I.
U.S. Postal Service inspectors and Federal Bureau of Investigation
agents arrested Ayferafet Yalincak yesterday morning at her home in
Pound Ridge, said Lisa Bull, a spokeswoman for the FBI.
Earlier this month, Ayferafet Yalincak stood inside the blue Colonial
on Upper Shad Road and declared her son's innocence. Gesturing with her
hands at a dark, unfurnished room, she scoffed that authorities and the
media believed she and her family lived the high life.
"Look at the luxury I live in," she said. "Those reporters have made
terrible mistakes and I am going to sue them."
Workers at 112 Mason St., where Ayferafet Yalincak supposedly operated
a mortgage financing business, described her as pleasant yesterday. But
state Attorney General Richard Blumenthal said his office is
investigating complaints about her possible involvement in mortgage
transactions in which loan application fees were collected but not
refunded when she failed to produce a loan.
"We are looking into how consumers may have been harmed and, if
possible, given restitution," Blumenthal said. "We're looking into her
possible connection to complaints we have received."
Chamber of Commerce leaders say Ayferafet Yalincak, going by the name
"Jackie," circulated in the business communities in New Canaan and
Greenwich.
Mary Ann Morrison, executive director of the Greenwich Chamber of
Commerce, said Jackie Yalincak enrolled her New Canaan business,
Classic R & C Mortgage, in the Greenwich chamber in October 2002,
attended a networking event and signed up for a lunchtime education
program on customer service. The company was removed from the rolls in
February for non-payment of dues, Morrison said.
Pam Ogilvie, director of the New Canaan Chamber of Commerce, said
Classic R & C Mortgage was a member of that chamber as well, though for
only for a few months. The company had an office at 71 Elm St. in New
Canaan, said Ogilvie, who added, "I don't actually recall seeing her
very often."
At the hearing yesterday, Ayferafet Yalincak was represented yesterday
by Eugene Riccio, one of her son's attorneys, but told Judge Ellen Bree
Burns that she would like to hire her own lawyer.
In response, Burns delayed Ayferafet Yalincak's bail hearing to next
Thursday. Another judge previously denied Hakan Yalincak bail, saying
he was a flight risk. Both are Turkish citizens.
Following yesterday's hearing, Riccio said he did not know whether
Ayferafet Yalin-cak would have enough money to hire her own attorney or
would get a public defender.
"It's up in the air," said Riccio, who declined to say how Hakan
Yalincak was paying his legal bills. "There is a miasma attending some
of these financial issues."
John
For Release: June 20, 2005
FEDERAL COURT FREEZES ASSETS OF FLORIDA FIRM WINDSOR FOREX TRADING
CORP. AND ITS OWNER, ANTHONY FRISONE, IN FOREIGN CURRENCY (FOREX) FRAUD
CASE
Registered Futures Commission Merchant COES FX Clearing, Inc. Consents
to Entry of Preliminary Injunction
WASHINGTON, D.C. -- The U.S. Commodity Futures Trading Commission
(CFTC) announced today that the United States District Court for the
Eastern District of New York issued orders freezing the assets of
defendants Anthony M. Frisone and Windsor Forex Trading Corp. (WFTC),
both of Parkland, Florida, preliminarily enjoining them from violations
of the anti-fraud provisions of the Commodity Exchange Act, and
prohibiting the destruction of books and records. The court took these
actions in a restraining order dated May 26, 2005, and two preliminary
injunction orders dated June 10, 2005.
The court’s orders stem from a CFTC complaint filed on May 25, 2005,
charging the defendants with fraud in the solicitation of customers to
trade foreign currency (forex) futures contracts. The CFTC
complaintalleges that, between at least December 2002 and March 2004,
Frisone and WFTC fraudulently solicited a total of approximately
$336,000 from at least 20 retail customers to open accounts to trade
foreign currency futures contracts. According to the complaint, the
solicitations falsely promised steady profits and limited trading
risks.
The complaint also alleges that WFTC acted as an exclusive agent for
defendant COES FX Clearing, Inc. (COESfx), a registered futures
commission merchant, in introducing foreign currency futures trading
accounts to COESfx, and further alleges that COESfx is therefore liable
as a principal for the acts of WFTC. COESfx consented to the entry of
the preliminary injunction against it without admitting or denying the
allegations of the complaint.
In its continuing litigation, the CFTC is seeking a permanent
injunction against each defendant, the disgorgement of ill-gotten
gains, the repayment of customer losses, and an award of civil monetary
penalties.
The following CFTC Division of Enforcement staff members are
responsible for this case: Grant Collins, Christine Ryall, Stephen
Morris, Patricia Gomersall, Paul Hayeck, and Joan Manley.
John
Citadel Wears Two Hats: As both Client and Market Maker
Mark Longo
For decades, they have been the cloak-and-dagger arm of Wall Street.
These mysterious entities trade on behalf of secretive clients,
devising elaborate strategies that move markets, and, in rare
instances, cause markets to meltdown. Like most unregulated entities,
they prefer to stay in the shadows, emerging on occasion to unwind or
increase their positions. Every few years, one of these entities
becomes so big that it can't help but draw attention to itself. Such
was the case in 1998 when Long Term Capital's highly leveraged spread
trading threatened to implode the global financial system.
The shockwaves from that near-disaster reverberated throughout the
financial markets and focused the attention of regulators on the
perceived shadowy world of hedge funds. The hedge fund industry world
never be the same, and neither would the world of options.
Rogue Memories
Today, one would be hard-pressed to find a fund that refers to itself
by the sinister title "hedge fund." The term carries with it far too
many memories of the rogue funds of the late 90's. Instead, they now
refer to themselves as "private investment funds," and their influence
is being felt across a number of financial markets. Although most funds
primarily trade equities, they were also among the first customers to
understand the hedging power of options. Selling upside calls against
stock positions has always been a popular trade in the hedge fund
playbook.
However, over the past five years, the relationship between hedge funds
and the options industry has evolved. "Six or seven years ago, the
hedge funds were almost nonexistent in the options business due to the
market's inefficiencies," says Ed Boyle, VP of Equity Derivatives at TD
Securities. "Now they've built or acquired sophisticated technology
while learning how to use options to decrease risk and enhancing
returns. I've heard numbers that as much as 50 percent of our customer
volume can be tied back to hedge funds."
Profit Center
Once seen as little more than a hedging tool, options have now become
lucrative profit centers for many funds. So lucrative, in fact, that
several funds have made the transition into options market makers. One
of the largest funds to make the transition so far has been Citadel
Investment Group, which has some $12 billion in assets.
"Three years ago, we made a decision to become options market makers
instead of just options customers," says Matt Andresen, President of
Citadel Execution Services and and the former chief executive of Island
ECN. "The two main reasons for this were the increasingly competitive
nature of the listings in the options markets and the increased
efficiencies provided by electronic trading. We believe that the
strength of these two trends will continue well into the future."
Andresen is a trading big leaguer. Before Citadel he served as head of
global trading at Sanford C. Bernstein for about a year. That was a
position he took in the fall of 2002, passing up the chief operating
officer job at Instinet after it bought Island. Andresen spurned
Instinet because he thought Bernstein was a better career fit. Now he
thinks options offer Citadel a better profitability prospect.
But this is an odd time to be entering the options fray. The options
markets are locked in a state of flux as they transition away from open
outcry and into a new era of electronic market making. Many large
trading firms, such as Knight Trading, have decided that the high risk,
low-margin world of options market making is not worth the effort.
Rapid Evolution'
However, while the evolution away from open outcry has been difficult
for many traditional option firms, private investment funds have always
been early adopters of trading technology. Their affinity for
technology makes them uniquely suited for this new era of electronic
market making. "The last few years have been a period of rapid
evolution in the options industry," says Andresen. "There are
opportunities today to add value in the marketplace by applying
quantitative research and cutting-edge technology. However, in order to
capture those higher levels of efficiency, and to capitalize on the
cost structure of the business, you have to make a substantial
investment in technology."
Matt Andresen, Citadel Execution Services
Unfortunately, trading pros like Andresen who are used to the efficient
execution of the equity markets may be in for a rude awakening.
Although the fragmentation that once plagued the options industry has
been mitigated by the linkage system, execution in the options markets
is still far from ideal. "The intermarket linkage between the options
exchanges is woefully outdated and needs to be addressed" says
Andresen. "When there is a superior advertised price on an away market,
we are required to get it for our customer. However, the level of
service on those away orders is spotty at best. This issue can't be
fixed with technology. It's a problem of incentive. What is the
incentive for an away market maker to give me a fast, efficient and
reliable fill? The answer is that he has none. If anything, he has a
disincentive, and that underlying problem has yet to be addressed."
Raised Eyebrows
The transition of private investment funds into market makers has
raised more than a few eyebrows in the industry. Some skeptics question
the motives of these new players, believing that their true intention
is to internalize their substantial order flow without providing any
real value to the marketplace. It remains to be seen whether the onset
of these powerful players will result in tighter markets and better
execution for customers, or yet another round of fervent
internalization and payment for order flow. "It is a complex issue,"
says Andresen. "Payment for order flow and internalization are, at
least for now, the competitive reality of the marketplace. We are faced
with a situation where all of our competitors do it, so we have to as
well. While we don't pay for orders directly in the options world, we
do participate in the programs at the options exchanges. On the ISE,
for example, the exchange collects the funds from us and the other
market makers, and then distributes those funds as the specialist
directs. It is just another cost of doing business in the options
industry today."
Citadel's entrance into the options arena marks a new era for the
industry. If its early success is any indication, then the transition
of funds into market makers will have profound ramifications for the
options markets. Citadel claims that it is already the largest
liquidity provider on the ISE and that it has made a substantial
investment in the fledgling Boston Options Exchange. In addition, they
currently provide liquidity on both the CBOE and PCX. Given Citadel's
growing market share, it won't be long before other large funds follow
its lead and enter the options fray. "We are one of the only private
investment funds that I know of that currently makes markets in
options," says Andresen. "I'm sure that many other funds use the
options markets as customers, but I'm not aware of many that make
markets in these products. Certainly not to the extent that Citadel
does." If the past is prologue, Citadel will soon have company.
Mark Longo is an options trader and a former member of the Chicago
Board Options Exchange. E-mail: ma...@marklongo.com
Mark Longo
John
Michael Scotti
The algorithm is not the enemy of the trader. At least that's what one
trading veteran says.
"I really don't think that my brethren out there on the buyside should
fear algorithms," says Larry Billimeck, a senior equity trader at
Nicholas-Applegate Capital Management, a $14-billion subsidiary of
Allianz Global Investors. Effective traders can't let these
mathematical marvels intimidate them.
"If you're afraid of them, you'll be left behind." Billimeck points out
that this smart-trading tool has its place. Still, he doubts algorithms
will replace skilled buyside traders.
Part of that logic rests in the fact that roughly 10 to 15 percent of
the firm's trading is done via algorithmic machines. Indeed, that
percentage has declined a bit, he adds. Billimeck says that algorithmic
trading at his firm is about equal to ECN usage. That means essentially
20 percent to 30 percent of the firm's flow is executed electronically.
"I really don't see those numbers going higher," he adds.
"Our PMs realize that we have a lot of caveats as it relates to
algorithmic trades," Billimeck says. Indeed, liquidity and readable
trading patterns are concerns. Lehman Brothers, Morgan Stanley and
Credit Suisse First Boston are his three main machines of choice, he
says.
These trading formulas are invaluable, Billimeck explains. That's
because the desk can use them to control the order. "I want to be able
to tweak the order on the fly," he adds.
Then buyside traders still have the opportunity to add value in a
low-return environment, Billimeck says. "I see our role today as even
more important," he adds.
Just as the markets have evolved, along with technological advances, so
has the role of the buyside trader, he says.
To remain an effective desk, he adds, the firm must watch broker
performance. The firm uses three trade-cost analysis vendors
Plexus, Elkins-McSherry & ITG
in its broker ranking. In fact, broker performance is part of its
pre-trade analysis and may help to dictate where an order goes, he
says.
Through some internal tweaking of software, the firm is able to put
each broker's TCA numbers side-by-side for comparison. "Even if a PM
says to pay a certain broker, we still look at their numbers to date."
Billimeck says. But always, Billimeck says, it is a people business.
The firm still must balance its relationships on both the research and
trading side. The annual research list is updated quarterly, which
takes on more importance as commission rates and trading volume
decrease and the amount of "free business" becomes scarcer. That's
primarily because soft dollar "chits" remain a constant: It takes
longer to pay those bills.
To counteract that, the firm has carved its core list of brokers down
to 80, which may still sound like a lot, but that number was about 320
before the bubble burst, Billimeck says. "We've got a smaller core, but
we haven't noticed any cut back on their service," he adds. "We still
maintain good relations with our brokers."
Billimeck says that despite a rise in algorithmic trading, there is a
willingness to trade blocks. Some of that may have to do with the fact
that "we are not in an environment of momentum," when a trader might be
more concerned about being "steamrolled."
"When there's low volatility, it's easier to trade blocks," Billimeck
says. Since few of its orders require capital commitment, it's common
to have an order with a broker, while the desk also has an order in
Liquidnet, he adds. Back in the fat 1990s, when firms were risking
capital, that would have been taboo. "I think everyone is comfortable
with that now," he adds.
Michael Scotti
John
The case for hedge fund oversight
The investigation of a Bradenton investor after his apparent suicide
suggests that he wasn't the success story he claimed.
By JENNIFER LIBERTO, Times Staff Writer
Published June 23, 2005
--------------------------------------------------------------------------------
To friends and family, Howard K. Waxenberg was a proud father, a clever
jokester and a successful businessman.
To the Securities and Exchange Commission, he was the mastermind of a
long-running, expensive Ponzi scheme that went undetected until he shot
himself in the head last month in his Bradenton condominium.
Waxenberg, 54, ran a hedge fund, a private investment firm that pools
clients' dollars into accounts to invest them in a variety of ambitious
ways.
Over 15 years, Waxenberg had collected more than $73.7-million from
nearly 200 mostly wealthy investors scattered from Los Angeles to
Boston, according to SEC records filed in federal court earlier this
month.
He won their trust despite losing his job and trading privileges in the
1980s for lying and stealing from his employer, a national brokerage
firm.
Investors apparently never made the connection. Neither did regulators.
When the SEC froze Waxenberg's hedge fund accounts earlier this month
and seized his records, 95 percent of the money he had collected from
investors was gone.
Waxenberg kept few records. He fabricated quarterly reports, which
arrived on investors' doorsteps with hefty checks. Investors thought
they were getting their promised double-digit returns, as much as 20
percent a year. In reality, most were just getting a little of their
own money back.
Four days before his death, Waxenberg sent two-sentence notes to some
clients, announcing his retirement with checks presumably returning
their original investment. Many of the checks bounced.
The SEC uses Waxenberg's case to illustrate why the agency wrote new
rules to regulate hedge funds, which lately have skyrocketed in
popularity, along with hedge fund fraud. The funds currently aren't
regulated but will be in February.
That comes as no comfort to the retirees, widows, doctors, lawyers and
accountants who gave Waxenberg millions.
"I knew one day it would end, perhaps with a slight detrition," said
Andrew Marias, a California investor who lost much of his employee
pension IRA to Waxenberg. "I never expected anything like this."
* * *
Howard Waxenberg never seemed like the type of guy who would steal
millions, say SEC attorneys, investors and longtime friends.
He had married Zelda Steiman, daughter of a wealthy San Diego builder
and philanthropist, Morris Steiman, who built synagogues and gave
millions to community causes, according to the San Diego Union-Tribune.
Zelda Waxenberg declined, through her attorney, to speak with the St.
Petersburg Times.
High school classmates who saw Waxenberg last year at their 35th
reunion say he had once distinguished himself in a class of 639 at Rock
Island (Ill.) High School by running a marathon around the school track
- circling it 105 times.
"He was very determined, but he also just did silly little things,"
said Rick Miers, 54, who grew up with Waxenberg.
At the reunion, he boasted of his teenage sons, Jake and Zack,
classmates say. He had put on weight but looked healthy enough,
greeting middle age with a graying beard, mustache and thin-rimmed
glasses.
He told his classmates self-deprecating stories of a corn-fed Jewish
Midwestern boy coming of age in downtown Los Angeles. They chuckled at
his notion that Rock Island, with a population of about 40,000, should
shape a 2020 Olympic bid for the Quad Cities, the area that encompasses
Rock Island and Moline/East Moline in Illinois, and Davenport and
Bettendorf in Iowa, population 400,000.
Classmates enjoyed reading Waxenberg's post reunion e-mails, which
included a quirky list of reasons to attend the 2009 reunion. "You can
see what everyone looks like after your Lasik surgery," he wrote,
signing off as "Wax." "You really do like going to the John Deere
museum."
Waxenberg left Rock Island for the University of California at Los
Angeles, where he graduated in 1973 with a psychology degree.
He bounced from job to job around Los Angeles until he landed with
Jefferies & Co. Inc., the national brokerage firm, according to
National Association of Securities Dealers records.
By the early 1980s, he lived in New York, where he had his first run-in
with securities regulators.
In 1983, Waxenberg was trading options for both his personal account
and Jefferies' account at the same time. According to NASD records, he
made sure that profitable trades went to his personal account and
losing trades went to his employer. He also faked paperwork for the
firm's books and records to cover up the scheme, the records state.
The NASD Board of Governors decided in 1987 to make an example of
Waxenberg by forever banning him from stock trading. Because of that
ban, he never would have qualified for membership in the federal
Commodities Futures Trading Commission, necessary to trade futures
contracts - which Waxenberg later boasted to clients was the key to his
big returns.
After Jefferies & Co. fired him, he moved to Southern California.
Three years after the censure, he opened a private hedge fund. He
worked alone and called the firm Downing & Associates, setting up an
office in Del Mar, Calif., a small seaside city north of San Diego.
Several investors said they never met "Downing"; they talked only to
Waxenberg.
Waxenberg told clients that he day-traded Standard & Poor's 500 futures
contracts on the Chicago Mercantile Exchange. In later years, he
promised 18 percent to 20 percent annual profits. Doctors, lawyers,
accountants and retirees say they believed in Waxenberg.
"The results spoke for themselves," said Nathan Greenberg, 86, of Palm
Beach, a semi-retired accountant who invested $4.4-million with
Waxenberg over eight years, money that now appears to be lost. "He was
consistent, and he kept his word up until the very end."
Part of the reason nobody questioned Waxenberg for so long is that his
hedge fund worked like any other small hedge fund. He sent investors
quarterly checks and annual audits without fail. He even went to hedge
fund conferences.
Over the years, he grew so popular and took on so many clients, he
started changing the rules on some of his funds. Early on, he'd accept
investments as small as $50,000. But in 2002, he set a minimum of
$250,000, requiring investors to "faithfully represent" they were worth
at least $1-million, excluding their home.
He also renamed the hedge fund after himself.
* * *
In June 2002, Zelda Waxenberg bought a $425,000 Bradenton condominium
behind the secluded walls of IMG Academies, a 200-acre sports
community, where son Jake could play soccer full time with the best.
IMG, where Venus and Serena Williams polished their tennis games, can
cost up to $70,000 a year, including tuition at the private school,
which Jake attended.
Howard Waxenberg leased a tiny office in a nearby office park. He never
hung a sign on his door, according to office neighbors.
In a 2002 letter to woo investor Robert Fischer of St. Louis, Waxenberg
said his company was 20 years old; it was only 12. He referred to staff
he didn't have. According to state records, Waxenberg never registered
his hedge fund with the Florida Department of Financial Services. No
state regulatory agency ever received a complaint against the company,
which was registered with the Secretary of State's Office.
This spring, when Waxenberg announced his retirement, he told those who
asked that the business was getting to be "too much of a strain,"
investor Nathan Greenberg recalled from a conversation.
People expected to at least get their money back.
"I did this with my eyes wide open," said investor Marias, who moved
$225,000 worth of retirement savings from the established Oppenheimer &
Co. to Waxenberg.
"With double digit returns," Marias said, "you don't really want to
find anything bad."
Marias, 64, is now contemplating whether to emerge from retirement.
Investors Fischer and Henry Shaw are skeptical. They want to know if
Waxenberg is really dead, or if he's living the good life in Argentina.
"We're afraid it's all gone," said Shaw, who would only acknowledge
that he had a "substantial amount" at stake.
The Manatee County Sheriff's Office confirmed that Waxenberg shot
himself May 15. Zelda Waxenberg found his body and called the police.
She said the last time she had seen her husband alive was about 3 p.m.
that day.
The SEC had been looking for Waxenberg weeks before his death, said Rod
Rawlings, who runs a real estate company two doors down from
Waxenberg's office.
When federal regulators searched the office, they found only a few file
cabinets and crates, six computers and two suitcases. There were no
formal books, records or client files.
But what little they found raised questions.
Quarterly statements mailed to investors in one fund showed gains of 10
percent during the last six months of 2004, while an audit found from a
Chicago firm for the same period showed the fund lost 3.41 percent of
its value.
The SEC says that, despite what he told clients, Waxenberg wasn't doing
much day-trading, not since 2002. He mostly invested in low-yielding
money market funds. They say he made up earnings statements each
quarter.
He even created fake IRS filings that confirmed his investors' supposed
annual profits, which means investors may have paid federal income
taxes on money they never earned.
Waxenberg pocketed at least $1.6-million from the investment funds,
according to a handful of personal bank records found by investigators.
The SEC doesn't know what more he might have taken, since records were
spotty.
On June 9, the SEC filed an emergency action in federal district court
in Tampa, freezing the assets of HKW Trading, LLC, Howard Waxenberg
Trading, LLC, and Downing & Associates Technical Analysis, and the
estate of Howard Waxenberg.
While going after the companies, the SEC admits it lacks a human
target. "No one's in charge; it was rudderless," said SEC attorney
Christopher Martin of Miami. "It's unfortunate."
Federal investigators wouldn't confirm or deny whether any criminal
charges might spring from the case.
Judge Susan C. Bucklew ordered Waxenberg's remaining investment
companies and funds into receivership, overseen by Tampa attorney
Burton Wiand.
Only a handful of Waxenberg investors have made claims. The SEC
encourages investors to call Wiand at (813) 228-7411 if they are owed
money.
The catch?
Only $3.9-million remains of the $73.7-million Waxenberg collected.
Times news researchers Cathy Wos and Carolyn Edds contributed to this
report. Jennifer Liberto can be reached at 813226-3403 or
lib...@sptimes.com
John
Pacific Exchange to Add Penny
By CYNTHIA SCHREIBER
DOW JONES NEWSWIRES
June 29, 2005; Page C4
The Pacific Exchange, whose parent PCX Holdings is being acquired by
Archipelago LLC, said yesterday it plans to start quoting and trading
options in pennies by the fourth quarter of this year.
The proposed change, which requires regulatory approval, would make the
San Francisco market the first U.S. options exchange to quote and trade
in individual cents rather than nickels and dimes. The exchange said it
will submit a rule filing to the Securities and Exchange Commission
soon and that it hopes to receive expedited approval.
PCX Chairman Philip DeFeo, who is also a director of Archipelago, said
the move to pennies for options would lead to more transparent and
efficient markets by "providing customers with the ability to get the
best price to the nearest penny, rather than the nearest nickel."
The move is unrelated to PCX's pending deal with electronic
stock-trading venue Archipelago, Mr. DeFeo said, but he noted that the
shift to pennies would "allow for everything to trade on one platform,
potentially." Stocks began trading in increments as small as a penny in
2001.
The move to penny increments also could reduce or eliminate the
controversial practice whereby exchanges and traders pay brokerage
firms for order flow. The thinking is that as the amount of profit from
the spread between bid and ask prices declines, so does the amount of
money a dealer is willing to pay to attract orders.
The introduction of penny-size quotes, which would narrow many spreads
between bid and ask prices for customers, also raises questions about
the capacity of vendors to disseminate what is already a staggering
number of option quotes.
Elizabeth King, associate director of the SEC's division of market
regulation, told attendees of a May conference that the commission
would "continue to evaluate whether the potential benefits of penny
quoting would justify the risk of less accurate information being
disseminated."
The Pacific Exchange garnered about 8.8% of total options volume in
May, making it the country's fifth-largest options market, according to
the Options Clearing Corp. Archipelago, which announced plans to merge
with the New York Stock Exchange in April, is expected to close its
acquisition of PCX in the third quarter.
Meantime, risk perception in the options market retreated as stocks
jumped on an upbeat consumer-confidence reading and a decline in
crude-oil prices. The Chicago Board Options Exchange volatility index,
or VIX, fell 0.94 point, or 7.5%, to 11.58.
Write to Cynthia Schreiber at cynthia....@dowjones.com
John
Renaissance's Man:
James Simons Does
The Math on Fund
By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL
July 1, 2005; Page C1
It is getting harder for hedge-fund managers to generate above-average
returns when their funds grow too big, right?
Tell that to James Simons.
Mr. Simons, a world-class mathematician who runs Renaissance
Technologies Corp., is creating a buzz in the hedge-fund world because
he is about to launch a fund that he claims could handle $100 billion
-- about 10% of all assets managed by hedge funds today. It will have a
minimum investment of $20 million, and is aimed at institutional
investors, according to early marketing materials.
Mr. Simons, whose net worth has been estimated at $2.5 billion, has
seen Renaissance's $5 billion flagship Medallion hedge fund earn an
average of 34% annually since it began in 1988, making it the most
successful fund during the period. These returns, which are audited,
come even after fees that now are -- get this -- 5% of assets and 44%
of all investment gains. That is more than double what other hedge
funds typically charge.
So far this year, Medallion is up about 12%, amid losses for the
overall market. Mr. Simons has done it with computer-driven, short-term
trading in various markets. The firm won't divulge details of its
strategy, even to its own investors. Other funds use the same strategy
but are far less successful.
The new fund will take a different approach: focusing on the U.S. stock
market and holding investments for more than a year.
Medallion hasn't been open to new investors for 12 years, and Mr.
Simons, 67 years old, has been returning money to existing investors,
convinced that returns would suffer if the fund got too big. In fact,
the firm is expected to return outside investors' remaining money at
year's end, leaving Mr. Simons and his employees as Medallion's sole
investors and the fund about as large as it is now. Dealing with few
investors has helped the publicity-shy Mr. Simons stay below the radar
screen.
Mr. Simons declined requests for comment. A Renaissance spokesman
wouldn't comment on the new fund, which will be called the Renaissance
Institutional Equities Fund.
The latest effort -- even if it never reaches the $100 billion mark --
would seem to run up against Renaissance's instincts to keep a lid on
assets. Indeed, many managers have found that more money under
management can put a crimp on results. Investors briefed on the new
fund say it will differ from the existing Medallion hedge fund by
aiming for tamer returns that would enable it to handle the greater
sums.
The new fund marks the latest encroachment of hedge funds into the
lucrative market of investing money for pension plans and other
institutional investors, turf that traditional money-management firms
like mutual funds have clung to. The fund will use complex quantitative
models, developed by the 60 or so mathematics and physics Ph.D.s on
staff. The fund will aim to beat the returns of the Standard & Poor's
500-stock index but with lower volatility.
Though Mr. Simons isn't well known, even on Wall Street, his track
record likely will spur strong interest in the fund, investors say.
Renaissance's 34% annual average returns since 1988 top every other
hedge fund in that time period, according to Antoine Bernheim, who
publishes the U.S. Offshore Funds Directory, which tracks over 1,000
hedge funds. By comparison, George Soros's Quantum Fund has climbed
about 22% annually since 1988, while the Standard & Poor's 500 rose
9.6% annually.
Medallion, which hasn't had a down month in the past two years,
according to one investor, has distributed so much money to its
investors over the years that they haven't been able to reinvest these
gains to take advantage of the big returns -- likely whetting investor
appetite for the new fund.
Though prior performance doesn't guarantee the new fund's success, it
will share Medallion's scientific approach, and is based on Medallion's
"technology," according to the marketing materials.
"Renaissance's returns are 10 percentage points higher than legendary
investors such as [Bruce] Kovner, Soros, Paul Tudor Jones, [Louis]
Bacon and [Mark] Kingdon," Mr. Bernheim says. "He's in a different
class from everyone else."
But while Mr. Simons will levy lower fees, such as about 2% of assets,
to attract interest in his new fund, he also may have to disclose more
details about trades than he is accustomed to. That is because pension
plans, and their consultants, usually require a full briefing about
strategies of firms they invest with.
"It's pretty much a black box. People that work there are sworn to
secrecy; it's a proprietary trading strategy," says Jeffrey Tarrant,
president and chief investment officer of Protege Partners LLC, based
in New York, an investor in Renaissance.
Mr. Simons began his career as a professor of mathematics, teaching at
the Massachusetts Institute of Technology and Harvard University. He
helped develop a geometry theorem, called Chern-Simons, that is a
critical tool for theoretical physics.
"It's startling to see such a highly successful mathematician achieve
success in another field," says Edward Witten, professor of physics at
the Institute for Advanced Study in Princeton, N.J., and considered by
many of his peers to be the most accomplished theoretical physicist
alive.
After breaking military codes for the government during the Vietnam
War, Mr. Simons turned to money management. He hires specialists in
applied math, quantum physics and linguistics for Renaissance's office
in East Setauket on New York's Long Island. Hardly any have a Wall
Street background. The firm relies on a system to make thousands of
rapid-fire, short-term trades daily to take advantage of small,
fleeting anomalies in various markets.
John
GOOG?
28/06/2005 HF Manager facing fraud charges for lying to investors
Reuters reports, hedge fund manager Jon Hankins faces fraud charges for
allegedly lying to investors with tales of double-digit gains while his
investment decisions actually led to heavy losses. Following an
emergency action filed by the Securities and Exchange Commission to
stop fraud at the fund last week, Hankins was removed from trading at
Tenet Asset Management and a receiver was appointed to manage the
affairs at the company’s Convertible Opportunities Fund. According to
the SEC, Hankins, who launched the fund last year after 17 clients gave
him roughly $22 million to invest in convertible arbitrage, lost
roughly $20 million on betting that search engine Google Inc.’s stock
would fall while it kept rising, while he lied to investors in person
and fabricated documents.
John
TRADING IN JUNE INCREASED 36%
CHICAGO - July 6, 2005
The Options Industry Council (OIC) announced today that June equity
options trading volume totaled 103,376,530 (42,195,746 puts and
61,180,784 calls), a 35.9% increase over the year-ago level of
76,047,664.
Equity options volume for the first half of 2005 is 39% higher than it
was in the first half of last year, a record-setting year that saw more
than 1 billion contracts traded. The rate of trading volume growth has
increased every month this year, beginning with a 2% rise over the
previous January through June’s 36% increase.
"The continued growth of equity options trading in the face of
historically low volatility and stagnant stock trading points to the
increased awareness of the versatility of options," said Michael
Walinskas, OIC Executive Director.
The Options Clearing Corp. reported total monthly volume - including
index options - at 114,175,409 contracts changing hands in June, an
increase of 36.2% over June 2004. This marks the ninth consecutive
month of total trading volume above 100 million contracts, a milestone
first reached in January 2004.
Equity open interest for June at month-end set a new record at
149,884,355 contracts, an increase of 10% over June 2004 month-end.
Equity open interest, the total number of options contracts not yet
exercised or allowed to expire, is seen as an indication of longer-term
investing in these instruments.
Additional volume statistics reported by The Options Clearing
Corporation include:
Average daily equity options volume: 4,698,933 (up 29.8% from June
2004)
Average daily total options volume: 5,189,791 (up 16.8% from June 2004)
June Highlights:
Total options volume added two new top-10 record days in June when
7,512,481 contracts traded on the 17th and 7,450,149 contracts traded
on the 16th, becoming - respectively - the seventh and eighth-highest
daily volume totals ever. June 10 equity options volume reached
6,665,514 contracts, ranking it as the seventh highest equity volume
day ever.
About OIC
OIC is a non-profit association funded by the U.S. options exchanges
and The Options Clearing Corporation. OIC's free resources include: The
Investor Services call center at 1-888-OPTIONS, an educational Web site
at www.888options.com, evening seminars throughout the continental
United States and Canada, educational literature and software.
John
living below their means with all the money they stole from investors.
19/07/2005 Court Receiver Retrieves Fast Cars, Condo and Jewelry From
Defunct Hedge Fund
NBC news reports that Guy Lewis, the court-appointed receiver for KL
Financial, has been recovering property bought by the firm’s principals
with money investors intended for the now defunct hedge fund.
According to a report in The South Florida Business Journal, Lewis has
obtained the deed to a condominium purchased by KL principal Won Sok
Lee and his fiancé Allison Koblenz. The two bought the condo on
exclusive Singer Island in Palm Beach County, Florida, for $1.9
million. Lewis hopes to sell it for about $3million. Koblenz has also
handed over a 2004 Maserati, a 2004 Porsche, several watches, a diamond
engagement ring and other jewelry, all allegedly purchased with
investors’ funds. Lewis will also be selling the furniture from the
firm’s posh office. KL’s conference room featured a $70,000 custom-made
table. The Securities and Exchange Commission shut KL down on March 1.
Lee and his partner Yung Bae Kim fled the country. A third principal,
John Kim, is cooperating with authorities. John Kim has already turned
over more than $1 million in personal assets.
Cedrick Johnson
Wow. Rediculous.
-c
-----Original Message-----
From: Chicago-Opt...@googlegroups.com
[mailto:Chicago-Opt...@googlegroups.com] On Behalf Of John
Sent: Saturday, July 23, 2005 8:25 PM
To: Chicago-Opt...@googlegroups.com
Subject: Re: News Articles
Here's an update on the KL Financial guys. Nice to see they were living
below their means with all the money they stole from investors.
19/07/2005 Court Receiver Retrieves Fast Cars, Condo and Jewelry From
Defunct Hedge Fund
NBC news reports that Guy Lewis, the court-appointed receiver for KL
According to a report in The South Florida Business Journal, Lewis has
obtained the deed to a condominium purchased by KL principal Won Sok Lee and
it for about $3million. Koblenz has also handed over a 2004 Maserati, a 2004
Porsche, several watches, a diamond engagement ring and other jewelry, all
allegedly purchased with investors funds. Lewis will also be selling the
freds...@aol.com
John
THIS FALL, MARGINS will be in the securities industry's spotlight.
A bill making its way through Washington contains proposals sought by
the futures industry that would effectively lower margins for trading
stock futures. Because the U.S. futures market is overseen by the
Commodity Futures Trading Commission, while the stock and option
markets are regulated by the SEC, the option industry is lobbying for
similarly reduced margins to apply to stock options.
At issue is the question of how margins ought to be calculated.
Currently, derivatives investors are required by their brokerage firms
to deposit money into their accounts-since the options and futures they
trade carry forthcoming obligations to buy or sell securities. Under
existing rules, such margins are specific to each trade and security,
and comes up to about 20% for options. Single-stock futures, which are
jointly regulated by the SEC and CFTC, have margin requirements of 20%,
while margin requirements for stock-index futures are between 5% and
10%.
Critics say, however, that this rigid approach doesn't reward investors
for diversification or risk management. For instance, an investor who
buys puts to hedge against a pullback will have to furnish more margin
than when he buys stock alone. Nor do margin requirements vary between,
say, options on Google and Microsoft even though one stock is far more
volatile than the other.
The solution? Portfolio margining, which considers different long and
short positions within an account to calculate its net risk, and which
is a standard commonly used overseas. "It's the modern,
capital-efficient way to quantify risk," says Peter Borish, chairman of
OneChicago, the Chicago-based exchange for trading single-stock
futures. While the precise monetary impact will vary from account to
account, the overall margins required are expected to be lower for most
customers. "It frees up a tremendous amount of the customer's capital,
and should help attract more global investors," says Chicago Mercantile
Exchange chairman Terry Duffy.
[cboe]
Not surprisingly, the futures market is pushing for portfolio margining
to apply to stock futures, and such a provision is in the proposed
Commodity Exchange Reauthorization Act of 2005, which would essentially
extend the CFTC's regulatory authority and which Congress is expected
to consider this fall.
This has the option industry in a tizzy -- not because it opposes
portfolio margining in principle, but because allowing it to apply to
stock futures without granting similar privileges to stock options
could create an uneven playing field for the derivatives markets. In a
July 20 letter to the Senate, the six U.S. option exchanges argued that
the proposal will destroy "regulatory parity" and provide "an unfair
competitive advantage" to stock futures. "Given this disparity in
margin levels, customers may choose security futures over security
options not because of the merits of the product but merely because of
its lower cost."
Besides voicing their objection, the option exchanges likely will step
up their own campaign to bring portfolio margining -- already available
to professionals like market-making firms -- to stock-option investors.
Last month, the SEC approved a pilot program, submitted some years ago
by the Chicago Board Options Exchange and the New York Stock Exchange,
which allows portfolio margining on a limited basis -- for options on
broad-market indexes and exchange-traded funds, and only for customers
whose accounts exceed $5 million. This raises hope, particularly as the
futures market presses for new margin rules, for more liberal
calibrations for stock-option traders.
That can't happen, of course, without a nod from the SEC, widely seen
as the stricter of the two regulators. It also remains to be seen how
the SEC will regard a plea for more liberal rules. Several brokerage
firms have pushed for portfolio margining, although a Securities
Industry Association spokeswoman would say only that it's "reviewing
these issues." An SEC spokesman declined to comment.
With lower margins come greater investor responsibility and the need
for more vigilant controls. After all, to reduce margins is to give
investors more leverage to wield. "Greater leverage can mean greater
risk," says David Kalt, chief executive of the online brokerage firm
optionsXpress. "And for some retail customers, too much leverage isn't
necessarily a good thing."
John
CBOE SETS NEW S&P 500 INDEX OPTIONS (SPX) TRADING RECORD;
Friday's volume of 716,375 contracts is busiest day ever
Open Interest stood at 7.34 million Friday Morning
CHICAGO, August 19, 2005 - The Chicago Board Options Exchange (CBOE)
announced that trading volume in options on the Standard & Poor's 500
Index options (SPX) set a new record today, Friday, August 19, with
approximately 716,375 contracts reported. The previous record of
565,500 was set earlier this year, on June 17th. Average daily volume
in SPX options for the year so far has been 255,888 contracts. Open
interest in SPX options stood at 7,340,141 contracts (2,646,147 calls
and 4,693,994 puts) at CBOE this morning.
CBOE, the world's largest options marketplace and the creator of listed
options, is regulated by the SEC. For additional information about the
CBOE and its products, access the CBOE website at: http://www.cboe.com/
John
Wed Aug 24, 2005 5:13 PM ET
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BOSTON, Aug 24 (Reuters) - U.S. financial regulators charged a former
hedge fund manager, who is serving time in prison, with civil fraud on
suspicion he lied about his fund's returns to tempt clients into
investing.
The Securities and Exchange Commission filed documents in U.S. district
court in the northern district of Georgia on Tuesday to force Barry
Alan Bingham, who ran the Bingham Growth Partners , L.P. hedge fund, to
return the money lawyers allege he stole.
Regulators said Bingham, who is serving a 366 day prison sentence for
defrauding his clients, got investors to put $459,483 in new assets
into the fund after he lied about past returns. They also said Bingham
stole money from the fund.
By November 2002, the SEC said the fund had no assets left because
Bingham had made losing bets and had stolen money.
As hedge funds become more popular, even with conservative investors
such as pension funds, regulators are keeping a much closer watch on
the fast growing $1 trillion hedge fund industry, which has avoided day
to day oversight for decades.
Starting next year, hedge funds that manage more than $30 million in
assets for 15 or more clients will have to register as investment
advisers with the SEC.
Already this year the SEC has moved to shut down a number of hedge
funds that allegedly defrauded their clients.
And the SEC is sending a stern message to investors and managers alike
that it is watching developments carefully. Last week, Walter
Ricciardi, the head of the SEC's Boston office, which will be on the
forefront of monitoring thousands of hedge funds, said: "We want them
to know there is a regulator that is not asleep at the wheel."
John
So you want to run a hedge fund
advertisement
By James Altucher 8/25/2005
As we see in the news every day, the hedge fund business is booming.
Assets have gone from $100 billion to $1 trillion in the past 10 years,
and the number of hedge funds has gone from 600 to 8,000.
In an eerie reminder of the late 1990s when downtown Manhattan was
dubbed "Silicon Alley" because of all the dot-com start-ups clustered
on Broadway, the area between 48th and 57th streets on Park Avenue is
now called "Hedge Fund Alley" because of the hedge funds that can be
found in every office building in between the two streets.
Additionally, industries have sprung up catering to the hedge fund
world: software companies for analyzing hedge-fund returns, databases
such as hedgefund.net and cogenthedge.com for checking up on your
favorite hedge funds, and even magazines such as Absolute Return or the
Trader's Monthly -- so you can see profiles and photos of your favorite
hedge-fund managers making $600 million a year. This media buzz is
tempting many traders to jump into the business
But the reality is, this is a business and it is not a pleasant one.
Like any business, nine out of 10 start-up funds are going to fail.
In fact, I wouldn't be surprised if more than nine out of 10 hedge
funds fail; of the start-ups I see, most don't even think of themselves
as businesses. They believe the success of their fund is determined by
their trading strategy or their stock-picking skills, and fail to
consider that a business requires many other disciplines in order to
succeed.
Hedge fund warnings signs
But even assuming that the trading strategy is a decent one -- a big
assumption because until the hedge fund starts, nobody really knows how
the managers will perform under pressure and how they will react to
their trading strategy during the first significant drawdown -- it's
still not enough. I have seen each of the largely operational mistakes
I outline below bring down entire hedge funds, even billion-dollar
ones.
Mistake No. 1: Offering monthly liquidity.
Many investors will want to bail the first time you have a drawdown,
precisely at the point when they shouldn't. These redemptions could
force liquidations that will cause further losses, and then further
redemptions.
Recently, I saw a good $150 million hedge fund go out of business
within three months when one of its seed investors had to redeem $50
million. Admittedly, when you are first raising money, you have to
cater to the fact that initial investors are taking "seeding risk" by
starting you up. They will want special conditions. But try not to cave
on this one; you need "sticky" money, and the only way to guarantee
that is contractual.
Mistake No. 2: Not charging a management fee.
You might have heard that Warren Buffett didn't charge a management
fee, which is true. When Buffett started his partnership in 1957, he
charged a 0% management fee and a 25% performance fee. But he also
worked in his pajamas out of his living room for a few years.
And he's Buffett. Case dismissed.
Mistake No. 3: Having investor concentration.
Again, this is hard to avoid in the beginning. But the downfall of many
hedge funds, or any business for that matter, is having that one
investor who can pull out and cause your entire business to capsize.
Mistake No. 4: Not having expenses set aside.
Everybody starts off thinking his trading strategy is the best and that
he will have great returns and no problem raising money. Listen. There
are 8,000 funds out there, and one in eight (or 1,000 funds) have
decent enough returns to keep growing their businesses. That's a lot of
competition for the dollars.
Additionally, there are many other features that institutions look for
when putting money to work: Does it fit their diversification plan? Do
you have low volatility? Do they like you? Do you have an office? (Yes,
this is an important box most institutions will need to check off.)
I know of one fund that had 36 up-months and couldn't get past the $10
million mark. Finally, after three years the manager made his way up to
$40 million and can now pay his living expenses (and the living
expenses of his four employees).
Mistake No. 5: Going for home runs.
There's a saying, "If you can return 1% a month, you'll raise $1
billion dollars." This statement is true. The largest allocators of
money are institutions that have modest goals of 8%-10% a year with low
volatility. Anybody returning 12% a year is a dream come true for these
allocators. Targeting 50% a year can cause you to quickly go out of
business if you miss, and even setting your goal at 50% could make you
too volatile for an allocator.
Mistake No. 6: Starting a hedge fund in the first place.
To reiterate, this is a tough business with a lot of competition. One
of the mistakes I've made in trying to survive in this business is
starting off with no pedigree. I never worked at Goldman Sachs (GS,
news, msgs), Morgan Stanley (MWD, news, msgs) or any of the big hedge
funds.
Last week, Deutsche Bank Asset Management distributed a survey that
discusses how pedigree is the most important characteristic (behind
performance) for an allocator. It's the difference between launching
with $300 million as opposed to $3 million. My background is that I had
a software business in the 1990s, sold it, started another software
business (which still exists), and then began trading, investing and
writing about investing.
I didn't come up through the traditional ranks -- and every step of the
way has been excruciatingly difficult.
In retrospect, I wish I had focused my efforts on somehow ending up at
a bank or at a large hedge fund, even taking entry-level jobs just to
learn the ins and outs and rise up through the ranks before going out
on my own. For one thing, you avoid all the start-up costs and
headaches. Second, you can focus on the investing rather than the
business aspects.
And third, the payout might be greater. Guaranteed salary in most
cases, plus a performance-based bonus that might be greater than what
you would've made starting your own fund. Similarly, there are shops
such as proprietary-trading firms that give up to a 90% performance
bonus, rather than the 20% one would get (hopefully) starting one's own
fund.
That said, I'm ultimately happy with my choices, even though regrets
come and go daily in this business.
James Altucher is a managing partner at Formula Capital, an alternative
asset management firm that runs several quantitative-based hedge funds
as well as a fund of hedge funds. He is also the author of "Trade Like
a Hedge Fund," and "Trade Like Warren Buffett." At the time of
publication, neither Altucher nor his fund had a position in any of the
securities mentioned in this column, although positions may change at
any time. Under no circumstances does the information in this column
represent a recommendation to buy or sell stocks.
John
Record
Thursday August 25, 11:11 am ET
CHICAGO, Aug. 25 /PRNewswire-FirstCall/ -- CME, the world's largest and
most diversified derivatives exchange, today reported record electronic
options on futures contracts trading volume in its benchmark CME®
Eurodollar interest rate product during the Wednesday, August 24
trading session.
A total of 86,829 CME Eurodollar electronic options contracts were
traded on CME® Globex®, the exchange's electronic platform that
operates virtually 24 hours every trading day. Electronic CME
Eurodollar option contracts traded yesterday represented 13 percent of
the total CME Eurodollar option volume of 685,464 contracts.
The new volume record eclipses the prior total of electronically traded
CME Eurodollar options of 77,082 on May 6, 2005, which represented 6
percent of the total CME Eurodollar options volume traded that day. The
previous record percentage for electronic CME Eurodollar options traded
was 9 percent on August 19, 2005, when 49,728 options contracts traded.
On August 14, 2005, CME integrated its enhanced options system for
trading CME Eurodollar options into its CME Globex electronic trading
platform creating broader access and around the clock liquidity for CME
Eurodollar options.
>From January through July 2005, the volume of CME Eurodollar option
contracts traded rose by 40.5 percent over the same period in 2004. For
that same period, the growth for CME Eurodollar futures was 42.3
percent and for CME Eurodollar futures and options combined 41.8
percent.
In July 2005, total CME Interest Rate products average daily volume
reached 2.1 million contracts, up 20 percent from 2004, an increase
driven by electronically traded CME Eurodollar futures. Electronic CME
Eurodollars represented 84 percent of total CME Eurodollar futures
volume in July, compared with 58 percent a year ago; and an average
daily volume of 1.1 million contracts, up more than 60 percent from the
same period a year ago.
Chicago Mercantile Exchange Inc. ( http://www.cme.com ) is the largest
futures exchange in the United States. As an international marketplace,
CME brings together buyers and sellers on CME Globex electronic trading
platform and on its trading floors. CME offers futures and options on
futures primarily in four product areas: interest rates, stock indexes,
foreign exchange and commodities. The exchange moved about $1.6 billion
per day in settlement payments in the first half of 2005 and managed
$43.7 billion in collateral deposits at June 30, 2005, including $4.0
billion in deposits for non-CME products. CME is a wholly owned
subsidiary of Chicago Mercantile Exchange Holdings Inc. (NYSE, Nasdaq:
CME - News), which is part of the Russell 1000® Index.
http://biz.yahoo.com/prnews/050825/cgth027.html?.v=22
John
CBOE CREATES "WEEKLYS:" FIRST SHORT TERM OPTIONS WILL LAUNCH ON FRIDAY,
OCTOBER 28, 2005; BASED ON SPX
Chicago, IL and Burgenstock, Switzerland - September 9, 2005 - The
Chicago Board Options Exchange (CBOE) today announced that it will
launch a new type of option, "Weeklys," on Friday, October 28, 2005.
Weeklys will have a life of one week, listing on a Friday, and expiring
the following Friday, thus providing an efficient way to trade options
specifically around certain news or events-- such as economic data or
earnings announcements.
The first Weekly option contract to be listed will be based on the
Standard & Poor's 500 Stock Index (SPX), will open on Friday, October
28 and will expire the following Friday, November 4. New series will be
listed each Friday, expiring the following Friday, except that no
Weeklys will be listed that would expire on the third Friday of each
month (expiration week for standard options).CBOE will soon announce
Weeklys on other classes.
"As the leader in product innovation-- from the first listed options
contract, to Index options and LEAPS, CBOE has created a number of
significant 'firsts.' Weeklys will join that list as a truly
significant new concept that has been brought to market by CBOE.
Weeklys will forever change, and broaden, the options landscape and the
way options are used," said CBOE Chairman and CEO William J. Brodsky.
"CBOE's creation of Weekly options is one of the great new products to
be brought to the market."
"CBOE's Weeklys offers an innovative way for customers to efficiently
take advantage of news driven market moves and short term trading
strategies," said CBOE Vice Chairman Edward T. Tilly. "Weeklys will
build on the liquidity provided by CBOE's deep pool of experienced and
well capitalized Index traders, and will add a whole new dimension to
the already versatile option product."
In general, Weeklys will have the same contract specifications as
standard options, except for the expiration date and time to
expiration. Initially, no more than five strike prices will be listed
per class, per expiration (two in-, one at-, and two out-of-the-money
strike prices), and no new series will be added between listing and
expiration.
SPX Weeklys will be European-style exercise and will offer the same
continuous, two-sided quotes as standard options.There are no position
or exercise limits; however, reporting requirements apply.
John
Citadel turns chaos into cash
Kenneth Griffin founded a hedge fund firm, became a billionaire and, at
36, is far from done
By Michael Oneal
Tribune staff reporter
Published September 11, 2005
When Hurricane Katrina began boiling into a Category 5 maelstrom in
late August, few people were watching her more closely than a team of
meteorologists perched 35 floors above Chicago's Loop at 131 S.
Dearborn St.
These weren't your typical weathermen.
They were part of a low-profile energy trading operation run by a
highly secretive Chicago-based hedge fund firm called Citadel
Investment Group PLC.
Snatched by Citadel three years ago from collapsed energy trading desks
like Enron and Aquila, this pack of traders had already been profiting
handsomely from the rapid run-up in oil and natural gas prices. As
Katrina bore down on New Orleans, threatening to disrupt the energy
markets even further, they stood to make millions more if they played
their cards right.
If you've never heard of Citadel, you're not alone. Beyond the
cloistered world of high finance, it might as well be invisible.
But over the last several years it has grown to be one of Chicago's
most innovative and influential firms by pouncing on disruptions large
and small ranging from massive hurricanes to tiny swirls in the bond
markets.
The firm's founder, a 36-year-old billionaire named Kenneth Griffin,
started his career trading convertible bonds from a Harvard University
dorm room almost two decades ago. Having built Citadel into one of the
world's biggest multistrategy hedge funds, he is quickly emerging as
one of Chicago's most powerful executives.
There are many ways to become a billionaire. But this is the moment of
the hedge fund. Over the last several years money has flooded into
these unconventional, largely unregulated pools of capital. And for
better or worse, they have multiplied like rabbits, now numbering 8,000
nationally with $1 trillion under management.
Greenwich, Conn., New York and London are commonly thought to be the
hedge fund hotbeds. But LaSalle Street has produced its share. The
Chicago area is home to more than 60 hedge fund firms managing $32
billion in capital, according to data provider Hedge Fund Research,
itself based in Chicago. There are also 25 "fund of hedge fund"
companies in the area--firms that invest in a variety of hedge funds.
Given the explosive failures of funds like Connecticut's Bayou
Management LLC recently, or Long Term Capital Management in 1998, it's
no wonder hedge funds court controversy and calls for regulation. But
by creating an institution with stability and staying power, Griffin
wants to prove that a well-managed fund deserves to be taken as
seriously as Goldman Sachs or Morgan Stanley.
"This is the opportunity of a lifetime and I certainly don't want to
squander it," he said recently during a rare interview in a Citadel
conference room overlooking Lake Michigan. "We're here to build one of
the great merchant banks in history. We want to be to finance what
Microsoft is to technology."
Like most hedge fund managers, Griffin has assiduously avoided
publicity, largely so competitors won't know what he's up to. But with
$12.5 billion in assets under management, Citadel has gotten too big to
hide. In a city that has lost thousands of jobs and a litany of
corporate headquarters in recent years, Citadel has been growing and
hiring like mad. It now employs more than 1,100 people, most of them
packed into nine floors on Dearborn Street.
Whether Citadel can keep growing is an open question. After years of
returns averaging better than 20 percent, investors say the firm is
crawling along closer to 2 percent this year, causing some to wonder if
it has gotten too big to find enough places to profitably invest its
capital. It has seen lots of turnover among key executives recently.
And some former employees say it is a brutal place to work, with
enormous expectations and little security.
Many experts also think the hedge fund business could be perched on a
bubble of its own. The Bayou fiasco demonstrates how quickly a fund can
melt away to nothing. Citadel is monitored by rating companies, but
because it has limited reporting requirements--even to its
investors--there's no real way to know exactly what sort of shape it is
in.
But Griffin insists that Citadel is in great shape and crouched at the
starting line of something bigger and more complex than a mere hedge
fund. At the moment, he has his eye on markets in Asia and wants to
build "a global team, deploying capital around the world looking for
opportunities with incredible entrepreneurial zeal."
If it weren't for Griffin's record, it would be easy to dismiss this
sort of talk as bluster. But ever since Harvard, he has done pretty
much anything he put his mind to.
Griffin grew up in Boca Raton, Fla., and spent his high school years
playing soccer and working on computers for cash. At Harvard he
discovered the world of finance and became fascinated by the arcane
market for convertible bonds, which are bonds that eventually convert
to shares of stock under various conditions. After studying "converts"
for a time, he decided that their prices often didn't reflect the true
value of their underlying stock. So he wrote a computer program to
model how the bonds should be priced and raised about $200,000 from his
family and a few other investors.
Griffin's strategy involved a classic hedge: He would buy a particular
convertible bond and then bet against the shares of the underlying
stock by selling them "short." (Short selling involves borrowing stock
and selling it at one price, and then buying it back later to repay the
lender, hopefully at a lower price.) This process, known as arbitrage,
meant that Griffin would limit his risk if the market moved against
him.
Trading of this sort required both a deep understanding of the
companies involved and a mathematician's grasp of the complex
relationships between the various classes of securities. To keep track
of his positions, Griffin convinced the authorities at Harvard to let
him install a satellite dish outside his dorm room window. Between
classes he would run back to his room to scan his computer screen and
make his trades. He also traveled frequently to New York to schmooze
with the people at the major brokerage firms who were in charge of
lending investors stock to sell short--a crucial part of his strategy.
"They were treated like clerks by the rest of the firm," Griffin
recalls. "They loved the fact that someone cared."
Alex Slusky, now a private equity investor in San Francisco but then
one of Griffin's Harvard friends, said few people in their class took
Griffin seriously. They simply didn't believe that he was earning
thousands of dollars trading bonds. Even Slusky was surprised when
Griffin left for Chicago after college instead of taking one of the
many offers he got from Wall Street.
"Most of us were very focused on finding high-prestige jobs in New
York," Slusky said.
On to Chicago, not Wall Street
But Griffin saw something different. He chose Chicago after meeting a
man named Frank Meyer who ran an early fund of hedge funds called
Glenwood Capital Investments. He promised Griffin a chance to bet on
himself and staked him some Glenwood cash to get started. When his
protege churned out a fat return in his first year using an updated
version of his Harvard computer model, Meyer knew he was onto something
and helped Griffin raise $4 million. Citadel launched in 1990.
In those days Griffin was as driven as he was quirky. One former
Glenwood colleague remembers going to a party with Griffin and watching
him stumble through one awkward conversation after another.
"You know this guy," the colleague said recently. "He's the smartest
kid in school and had no patience for the social aspects of life."
But this colleague could only shake his head in 1992 when the tunnels
under the Loop flooded disastrously one day shutting down all
electricity--and trading--south of the Chicago River.
"Ken rented a hotel room on the north side of the river and somehow got
his Bloomberg [market data] terminal up and running," the colleague
said. "I saw the Bloomberg guy a week later and he said that was
impossible."
Early on Meyer gave Griffin a crucial piece of advice that came to form
the core of Citadel's strategy. "He asked me what I wanted to be,"
Griffin recalled, "and I told him I wanted to run the best convertible
bond fund in the world."
But Meyer warned him that any strategy, no matter how lucrative, runs
out of gas eventually. Other investors inevitably get wind of the
profits being made and pile into the market, eliminating the sorts of
inefficiencies Griffin had been exploiting.
"Create a world-class platform that can pivot between different asset
classes," Meyer told him.
Griffin took Meyer's advice to heart and gathered around him a core
group of key investors and technologists. He hired quantitative
analysts with doctorates in fields like mathematics and astrophysics.
He spent like NASA on computers and programmers, and attracted the best
traders he could find. The goal was to mold them into a high-tech
factory for investment ideas that could identify and exploit new
investment opportunities faster than the old ones dried up.
The key to this process was marshalling technology to help see through
the dense thickets of modern financial markets. Citadel's idea factory
captures mountains of financial and pricing data. Traders, analysts and
technologists then work as closely integrated teams to find the
patterns or inefficiencies within it. Once an opportunity presents
itself, the groups form strategies--often automated by computers--to
both exploit the opportunity and manage, or hedge, the risk that
something might go wrong, which it often does.
This often involves trading massive volumes of securities and taking
advantage of the tiny spreads between long and short positions. A
massive back office sorts out the extraordinary amount of accounting
that results. One way Citadel prevents expensive blow-ups is by
striving to make sure all these trades are settled each day.
Like a regular operating business, Citadel has its own form of R&D. The
firm often will study a trading strategy for months, even years, before
it is ready for prime time. Computer models run the strategies using
reams of historical data to see if all the expensive thinking holds up
against market reality.
"He is very, very detailed in his analysis," says one investor who
asked not to be named. "It's like if you were making computers and then
you decided to go into printers. You have to do the research and make
sure printers are profitable."
These days, Citadel is as much a technology operation as it is an
investment house. The company has 1,000 servers and 1,000 miles of
network cabling. It has the capability to store more than one-half a
petabyte of data--half a quadrillion bytes--or 50 times the size of the
print collection at the Library of Congress. Technologists comprise
about half the firm's employment. There are 85 PhDs.
To pay for all of this, Griffin devised an unusual and bold
compensation scheme. Most hedge fund managers abide by what is known as
the "two and 20" fee structure. They take 20 percent of the profits up
front and then 1 percent to 2 percent of total assets as a management
fee. Griffin does it differently. Citadel also takes 20 percent of the
profit but it charges investors full freight for its expenses. In some
years this has ranged as high as 6 percent.
Griffin also demands another extraordinary vote of confidence: He locks
up investor capital for a number of years. Citadel's only really bad
year came in 1994 when the bond market blew up and investors ran for
the exits, forcing the firm to sell positions at a loss to cover
redemptions. Vowing never to be vulnerable to that sort of run again,
Griffin convinced his investors to leave their money in the fund during
crises so Citadel could capitalize as others sold under duress.
This system has allowed Citadel to exploit some of the investment
world's richest opportunities over the past decade. After the Russian
financial meltdown in 1998 caused Long Term Capital Management to fail,
threatening the entire financial system, Wall Street's proprietary
trading desks froze in place. Citadel, with its locked-up capital,
became one of the few buyers in the abandoned fixed-income market and
cashed in big time. In 1999, Griffin launched a distressed securities
business and then a long-short equity fund in 2001 after the stock
market bubble popped. He launched the energy business in 2002, when
Enron and other energy traders collapsed. Griffin and several other
executives fanned out to hire their best people and within six months
the firm had built its own energy trading business from scratch, a
massive undertaking.
Citadel has also built a lucrative business as one of the biggest
market makers in options over the last several years. And most
recently, it has jumped full-bore into the reinsurance business, which
is the practice of insuring the insurance companies. This brought the
firm face to face with Hurricane Katrina as well. But Griffin said the
losses were planned for and were offset by gains in the energy trading
business.
Griffin himself has given up trading. His job is management. Having
absorbed the advice of countless business books and a set of
consultants, Griffin has become an acolyte of the Jack Welch school of
data-driven decision making. His goal is to bring discipline to the
unruly world of hedge fund investing and create an institution that
isn't beholden to a few star traders.
Secrecy at many levels
Keeping the ball rolling is Griffin's major challenge. And nobody
outside the well-secured halls of Citadel really knows for sure how the
firm does in its various strategies. That's because Griffin has done
everything possible to wrap the firm in secrecy. Employees sign thick
agreements that prevent them from talking to outsiders or forming
competing funds if they leave. Investors, too, are discouraged from
talking.
All of this can make Citadel seem like a branch of the CIA. When
reached at his home in New Jersey and asked for his thoughts about
Citadel, a former quantitative analyst named Vlad Finkelstein chuckled
sardonically and said, "I cannot talk about Citadel. It would be too
costly."
Some big money players complain that all the secrecy makes it
impossible for them to invest with Citadel no matter how good the
returns.
"They've always been relatively secretive and relatively opaque," said
one Chicago fund manager who once invested with Citadel but doesn't
now. "We couldn't take the lack of information. As smart as we think he
is and as much respect as we have for the organization, we didn't know
what was going on. So we just said we can't do this."
The investors who do decide to put up with all the fees, restrictions
and secrecy do so because Griffin has made them scads of money. But
"what happens when your returns become less attractive?" asks one rival
hedge fund manager. "All of a sudden you're the high-cost producer."
Already the returns have slowed and some observers point out that the
bigger a firm gets the harder it is to find places to put money
profitably. Citadel has lost some of its better minds in recent years,
when many of the original team made their fortune and left the firm.
All of this leaves Griffin out on the frontier with a massive
imperative to constantly find new ways to make money.
"What hedge fund has 500 programmers?" asks Griffin's mentor Frank
Meyer. "When Ken Griffin was small he could learn from other people.
When you don't have others to learn from you're at risk."
Griffin's response to this sort of thinking is simply to work harder
and turn up the heat on the rest of the organization. He is unforgiving
when performance lags. For much of the past year the bond market has
been trouble, especially the market for convertibles, traditionally
Citadel's bread and butter. So earlier this year, against the wishes of
that unit's top executive, Griffin cleared out people he considered
underperformers. The top manager left, too.
"What took place is that the results weren't there," Griffin said.
Mike Pyles, Citadel's top human resources executive, said the credit
group suffered from an ailment the firm simply can't afford: an
unwillingness to change. When a market tanks, he said, people in that
group have to be willing to give up the trading system they're
comfortable with and go back to ground zero to devise a new one. Some
people are capable of that. Others aren't.
Griffin puts it a little more bluntly: "Every business slows down. What
separates the men from the boys is the ability to adapt to that
change."
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