C(S,T) = SN(d1) - Ke^{-rT}N(d2)

Sometimes, after we make a trade, we wonder...who is the idiot on the other side of our order? 

The Thanksgiving break has always given us a chance to catch up on our reading.  When Genius Failed, Roger Lowenstein’s blow-by-blow account of the debacle at Long-Term Capital Management, was an instant classic back in the day.  Myron Scholes, one-half of the famed Black-Scholes duo, plays a prominent role in the story.

Lowenstein relates a story that took place during LTCM’s capital raising roadshow, and we believe the exchange is typical of how cocky traders and investors really feel about the anonymous souls who take the other side of their trades…

At one point during the road show, a group including Scholes, Hawkins, and some Merrill people took a grueling trip to Indianapolis to visit Conseco, a big insurance company.  They arrived exhausted.  Scholes started to talk about how Long-Term could make bundles even in relatively efficient markets.  Suddenly, Andrew Chow, a cheeky thirty-year-old derivatives trader, blurted out, “There aren’t that many opportunities: there is no way you can make that kind of money in Treasury markets”. Chow, whose academic credentials consisted of merely a master’s in finance, seemed not at all awed by the famed Black-Scholes inventor.  Furious, Scholes angled forward in his leather-backed chair and said “You’re the reason---because of fools like you we can!” The Conseco people got huffy, and the meeting ended badly.  Merrill demanded that Scholes apologize. Hawkins thought it was hilarious, he was holding his stomach laughing.

Alas, book smarts don’t always triumph over common sense.  The hedge fund imploded and Conseco went bankrupt.  It was a room full of bloated egos...and longer-term...losers.

Tomorrow UTC readers should give thanks...for all the fools out there willing to take other side of your trades. But keep the hubris in check.

Because even the smartest investors can end up looking like turkey’s.

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