How This Bank Got Wiped off the Map

There Once Was a Boy From Watford [Morning Reckoning] October 19, 2023 [WEBSITE]( | [UNSUBSCRIBE]( There Once Was a Boy From Watford - Perhaps you’ve heard this old horror story… - This is what happens when what you don’t understand collides with what you didn’t expect. - I’ll tell you the options horror story without advanced mathematics or “Greeks.” Asti, Northern Italy October 19, 2023 [Sean Ring] SEAN RING Good morning Reader, I was looking through my old files and remembered that I hadn’t told you this story yet. When people ask me why I’m so against shorting options, this is what I tell them. I’ll elaborate on what can happen — though admittedly very rarely does - when you’re short volatility and you don’t know what you’re doing. The Rogue Trader Nick Leeson was an ordinary boy from the ordinary London suburb of Watford. He was going to live an ordinary life until he got the opportunity to work in The City. That’s The City of London, where serious international banking gets done. It’s the British bastion of capitalism, whose profits pay for the folly of the British Welfare State. But Nick didn’t have the right background or proper accent to succeed there. So, when he was given the opportunity to move to Singapore, he jumped at the chance. As a side note, when mediocre bankers are sent from London to Hong Kong, they’re pejoratively called FILTH — Failed In London, Try Hong Kong. Hint, hint… Nick got on a plane and went to Singapore, where he was simultaneously named a floor trader and Head of Settlements. In the early 90s, that nonsense could happen. Let me confirm: it means he was responsible for checking his trades. And yes, you’re right; it was a recipe for disaster. Without overegging the pudding, let me get straight to the trades that brought down Barings Bank, HM The Queen’s Bank, in 1995. Much of this is by memory, as my edition of Rogue Trader, Leeson’s autobiography, was lost in one of my many moves. Thus, any errors are my own. [PREDICTION: The Next Trillion-Dollar Stock]( [Click here to learn more]( In 2007, he predicted Facebook would become a $100 billion company. In 2010, he predicted Apple would reach a three-trillion-dollar valuation. In 2013, he called Bitcoin -- before it rose 50,000% and ultimately reached a trillion-dollar market cap. And now, this A.I. Genius is stepping into the spotlight to predict the next-trillion stock. [To see his shocking new reveal, go here now](. [LEARN MORE]( Straddle This! I’m going to proceed in a plain English manner, not making it too geeky or Greeky. If you’re a pro, please forgive me for the oversimplification. First, let’s get long. [chart] This is the payoff profile of a long call position at expiry. It’s a bullish trade. In this case, the call buyer pays $5 per share for the right to buy 100 shares later at $225. Therefore, the breakeven point is $5 + $225 = $230. The buyer can only lose his premium, no more. That’s still 100%, to be sure, but it’s not as much as he may lose holding the shares. The upside is unlimited. Think TSLA call buyers and how much they made in the recent past! Next is a long put option. [chart] A put option is where the buyer has the right to sell shares at a specific price in the future. In this case, the buyer paid $6 for the right to sell these shares for $225. This is a bearish trade, as the buyer must think the price will decrease. The breakeven point is $225 - $6 = $219. That is also the maximum gain, as it’s not unlimited (though it’ll feel almost as good)! So, a long call and a long put, separately, are directional trades. But what happens when we put them together? Remember, these calls and puts will have the same underlying, strike price, and expiry. [chart] Et voila! You’ve got a volatility trade! That is, you’re long volatility. (I always write the “volatility” next to the payoff profile to make it easier for grads to remember.) Looking at that payoff profile, you see something obvious: it doesn’t matter which direction the underlying goes, as long as it goes far. So, you’ve got the unlimited gain potential from the call. And you’ve got the limited but substantial potential gain from the put. Thus, there are two breakeven points. This will be the strike price plus and minus the combined premiums. The upside breakeven point is $225 + $11 = $236. The downside breakeven point is $225 - $11 = $214. As long as the underlying either goes up beyond $236 or down below $214, you will make money. Of course, the pros will manage these trades minute to minute and adjust accordingly. However, this is something retail investors, who have other jobs, will find exceedingly difficult to do. But for now, know that a long straddle is a long volatility trade. Derivatives Are a Zero-Sum Game Derivatives are a zero-sum game. That means no wealth is created or destroyed by trading them. Of course, there are winners, and there are losers. It’s capitalism at its very finest. But overall, nothing is lost. That means if you can buy a straddle, then someone must have sold it to you. Someone like, say, Nick Leeson. To illustrate, let’s take the long straddle we just looked at and flip it upside down. [chart] It’s the exact same trade but from the seller’s perspective. Let me ask you this: what’s the best thing that can happen to the seller? Answer: nothing. Literally. If the straddle expires at $225, the seller will keep the $11 per share premium. Anywhere else, he doesn’t maximize his gain. Below $214 and above $236, he loses money. Again, if a pro entered this trade, he’d keep his eye on it and manage it accordingly. He can use stop-loss orders, close out a side, or turn the straddle into an iron butterfly. Don’t worry about these things right now. Because if your name is in God’s book on a particular day, he will get you no matter what. And that happened to Nick Leeson. How Straddles Killed Nick Leeson and Barings Bank Leeson was already down. He was supposed to be running an arbitrage operation, taking no risk. But he couldn’t help himself. Leeson already racked up millions in losses. Moreover, he was losing nearly from his first day in the office in 1992. It just turned 1995, and he was running out of options - no pun intended. So how could he get that money back without incurring much more risk? Boom! He could sell straddles! That would let him take in the premium from both the calls and puts. The markets are quiet anyway, so it’s a sure thing. The date was January 16, 1995. Leeson sold a bunch of straddles on the Nikkei Index. He probably went to Harry’s Bar on Boat Quay after work, thinking all was well. Incidentally, Harry’s is next to my favorite SG watering hole, The Penny Black. Harry’s used to have a plaque on the bar that read, “Here sat Nick Leeson.” I saw it myself! Then, in the early hours of January 17, 1995, the unthinkable happened. The Kobe Earthquake struck. [chart] Leeson, already down GBP 208 million, was crushed. The Nikkei gapped down on the open. Of course, the call options would expire worthless, but he was now short deeply in-the-money puts. To counteract this, Leeson bought futures as the market “couldn’t go down anymore.” But, of course, it did — much, much more. Nick Leeson’s losses totaled GBP 827 million, about $1.4 billion. That doesn’t sound like much now, but it was enough to wipe Barings, The Queen’s Bank, from the map. A friend once told me of an event he held in Singapore. A member of the Royal Family was present to open the event. My friend pointed out the window onto Raffles Place and said, “That’s where Barings office used to be.” The reply was, “My family lost a lot of money that day.” That is the story of Nick Leeson, told as plainly and as “Greeklessly” as I can. It’s a great cautionary tale to retail options traders and professionals alike. Heck, it can be said that Leeson inadvertently wrote today’s derivatives regulatory structure. The upshot is there are far better, less risky and less stressful ways to participate in the market than by shorting options. Have a great day today! All the best, [Sean Ring] Sean Ring Contributing Editor, The Morning Reckoning feedback@dailyreckoning.com X (formerly Twitter): [@seaniechaos]( [America no longer a superpower because of Biden?]( [Click here to learn more]( [Ever heard of America’s “Doomsday Deal”?]( It’s a deal so vital to our country’s wealth and security… Every President for 50 years has defended it at all costs. Until Calamity Joe Biden. [Biden broke the deal](. And I now predict… The America we love is doomed. And the biggest wealth transfer in US history is now underway. [>>See the truth about Biden’s terrible mistake HERE<<]( [LEARN MORE]( In Case You Missed It… Headlines Will Be Your Downfall Greg Guenthner, Editor [Greg Guenthner] GREG GUENTHNER Good Morning Reader, We’re searching for snapbacks as the October market chop continues this week… Stocks are already attempting to recover from last week’s slump as the major averages all posted strong gains on Monday. The much-needed September pullback has passed and traders are waiting and watching for the market to tip its hand. Some market pundits are convinced stocks are gearing up for a big year-end rally. Other prognosticators see nothing but doom and gloom on the horizon — along with a major market correction. I believe there’s credible evidence supporting both scenarios. But the market doesn’t care what you or I (or anyone else) thinks. We could gather the world’s most prominent bullish and bearish investors for a weeklong retreat to debate the merits of their arguments. Yet this exercise would have no bearing on how stocks finished the year. The world is much too complex for market action to work out this way. We’re always just a war, pandemic, or terrorist attack away from having to rethink just above everything we thought was true at the time… Right now, the averages are stuck in a sideways struggle. It’s a frustrating situation for many traders and investors since the market isn’t trending higher or lower. But I believe we can put these choppy periods to good use. Instead of forcing too many ill-advised trades, we’ve discussed some of my bigger-picture market philosophies [over the past several weeks](. And as the chop continues, it feels as if the action is subtly confirming the most important messages from our discussions: We have no edge in the markets… We cannot discover any magical formula that will give us an advantage over other investors… Fundamental information has no short-term predictive power… And, most importantly: Price is the most effective indicator we can use to time our buys and sells. While these concepts are relatively simple, they are far from easy to put into practice. Fortunately, the markets are gracious enough to give us another chance to get it right. Our best opportunities are always right around the corner, no matter how we’ve performed in the past. If we pay close attention and are willing to learn from our mistakes, the market will offer teaching moments we can use to get better every single day. A Big Bitcoin Fakeout One of these amazing teaching moments just so happens to be playing out this week. The story isn’t over yet, but the initial reactions as it began to unfold tell us a lot about how markets work in real time — and how emotional investors typically react to new information. It all started early Monday morning as futures were attempting to rally off their overnight lows. Bitcoin was also starting to tick higher after pushing toward $28K on Sunday evening. Traders were on the lookout for a bounce in the tech growth and crypto following Friday’s ugly performance. But they had no idea what would happen next… Just before the opening bell, Bitcoin suddenly exploded higher. It looked like it was starting to squeeze as the price jumped from $28K to almost $30K in just a couple minutes. But after a little digging, it appeared that this potential breakout move was triggered by a social media post. A crypto Twitter account with almost 2 million followers reported that the SEC approved BlackRock’s iShares spot Bitcoin ETF. Bitcoin was rocketing on the SEC approval news. There was just one problem: no other sources seemed to be able to confirm the information. After briefly hitting $30K for the first time since August, the rally began to unwind almost as fast as it appeared. By 9:45, Bitcoin was well below $28K again. Forty-five minutes later, the same Twitter account that initially spread the news was posting an apology: [cointelegraph tweet] Cointelegraph later revealed that they took a tip that turned out to be a fake Bloomberg headline. It’s still unclear whether this was a prank or someone attempting to manipulate the market. But as far as I’m concerned, the reasons don’t matter at all… You Can’t Trade the News To be clear, I don’t fault the folks at Cointelegraph for the SEC mixup. Whether the news is “real” or “fake” doesn’t really matter. What does matter is how the market reacts to the information. In this case, an extreme influx of buyers swooped in when the headline first hit social media, bullying the price of Bitcoin sharply higher. But what happened to these early news reactors? I suppose some of the more savvy buyers might have set alerts that allowed them to get in minutes — or maybe even 20-30 seconds — after the news broke. But there’s no realistic chance that any random trader was able to get in at the exact moment the market started moving. Accounting for slippage, I doubt it would even be possible to make a profit on a move like this. In a more likely scenario, you’d buy in the $29K range, then get stopped out minutes later as the move failed. Or, even worse, you would buy and then watch your position immediately sink into the red as Bitcoin reversed. As we discussed earlier, this story isn’t over yet. Bitcoin did manage to slowly move higher into Monday evening following the initial attempt at $30K. But I have to assume there are more than a few traders with underwater positions who attempted to play the headline. The takeaway is simple: You can’t trade the news or time your short-term buys and sells by the headlines. Whether you're tracking a planned earnings announcement or a surprise event, it’s impossible to know if the buying or selling force from the initial reaction will continue. This is also one of the main reasons I never attempt to play earnings. You never know how a stock will react — even to solid numbers. The CFO could hiccup during the conference call and send the stock down 5%. Or, you might have to sit through a couple of false moves while the market attempts to sort out its final reaction to the new information. The purest breakouts in the market that are most reliable happen because of supply and demand dynamics. Aggressive sellers overwhelm demand, or aggressive buyers chew through supply at critical levels. Once resistance is defeated, the stage is set for an extended move that can play out for days, weeks, or even longer. That’s where the real money is made. Best, [Greg Guenthner] Greg Guenthner Contributing Editor, Morning Reckoning feedback@dailyreckoning.com Thank you for reading The Morning Reckoning! We greatly value your questions and comments. Please send all feedback to [feedback@dailyreckoning.com.](mailto:dr@dailyreckoning.com) [Sean Ring] [Sean Ring, CAIA, FRM and CMT]( is a former banker and financial educator and is the editor of the Rude Awakening. Sean has trained interns and graduates from Goldman Sachs, Morgan Stanley, Citi, Bank of America, Standard Chartered Bank, DBS (Singapore), the Abu Dhabi Investment Authority (ADIA), Bank Indonesia (the central bank), HSBC, Barclays, RBS, and BlackRock. He knows the global economy is being corrupted by forces that most people can't understand and has used his unique and worldly experiences to help people navigate the markets. [Paradigm]( ☰ ⊗ [ARCHIVE]( [ABOUT]( [Contact Us]( © 2023 Paradigm Press, LLC. 808 Saint Paul Street, Baltimore MD 21202. By submitting your email address, you consent to Paradigm Press, LLC. delivering daily email issues and advertisements. To end your The Daily Reckoning e-mail subscription and associated external offers sent from The Daily Reckoning, feel free to [click here.]( Please note: the mailbox associated with this email address is not monitored, so do not reply to this message. We welcome comments or suggestions at feedback@dailyreckoning.com. This address is for feedback only. For questions about your account or to speak with customer service, [contact us here]( or call (844)-731-0984. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized financial advice. We allow the editors of our publications to recommend securities that they own themselves. However, our policy prohibits editors from exiting a personal trade while the recommendation to subscribers is open. In no circumstance may an editor sell a security before subscribers have a fair opportunity to exit. The length of time an editor must wait after subscribers have been advised to exit a play depends on the type of publication. All other employees and agents must wait 24 hours after on-line publication or 72 hours after the mailing of a printed-only publication prior to following an initial recommendation. Any investments recommended in this letter should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company. The Daily Reckoning is committed to protecting and respecting your privacy. We do not rent or share your email address. Please read our [Privacy Statement.]( If you are having trouble receiving your The Daily Reckoning subscription, you can ensure its arrival in your mailbox by [whitelisting The Daily Reckoning.](