The Big Short_ Inside the Doomsday Machine - Michael Lewis [57]
"We couldn't believe people would sell us these long-term options so cheaply," said Jamie. "We went looking for more long-dated options."
It instantly became a fantastically profitable strategy: Start with what appeared to be a cheap option to buy or sell some Korean stock, or pork belly, or third-world currency--really anything with a price that seemed poised for some dramatic change--and then work backward to the thing the option allowed you to buy or sell. The options suited the two men's personalities: They never had to be sure of anything. Both were predisposed to feel that people, and by extension markets, were too certain about inherently uncertain things. Both sensed that people, and by extension markets, had difficulty attaching the appropriate probabilities to highly improbable events. Both had trouble generating conviction of their own but no trouble at all reacting to what they viewed as the false conviction of others. Each time they came upon a tantalizing long shot, one of them set to work on making the case for it, in an elaborate presentation, complete with PowerPoint slides. They didn't actually have anyone to whom they might give a presentation. They created them only to hear how plausible they sounded when pitched to each other. They entered markets only because they thought something dramatic might be about to happen in them, on which they could make a small bet with long odds that might pay off in a big way. They didn't know the first thing about Korean stocks or third world currencies, but they didn't really need to. If they found what appeared to be a cheap bet on the price movements of any security, they could then hire an expert to help them sort out the details. "That has been a pattern of ours," said Jamie Mai. "To rely on the work of smart people who know more than we do."
They followed their success with Capital One with a similar success, in a distressed European cable television company called United Pan-European Cable. This time, since they had more money, they bought $500,000 in call options, struck at a price far from the market. When UPC rallied, they turned a quick $5 million profit. "We're now getting really, really excited," says Jamie. Next they bet on a company that delivered oxygen tanks directly to sick people in their homes. That $200,000 bet quickly turned into $3 million. "We're now three for three," said Charlie. "We think it's hilarious. For the first time I could see myself doing this for a really long time."
They had stumbled either upon a serious flaw in modern financial markets or into a great gambling run. Characteristically, they were not sure which it was. As Charlie pointed out, "It's really hard to know when you're lucky and when you're smart." They reckoned that by the time they had a statistically valid track record they'd be dead, or close to it, and so they didn't spend a lot of time worrying about whether they'd been lucky, or smart. Either way, they knew they didn't know as much as they should, especially about financial options. They hired a PhD student from the statistics department at the University of California at Berkeley to help them, but he quit after they asked him to study the market for pork belly futures. "It turned out that he was a vegetarian," said Jamie. "He had a problem with capitalism in general, but the pork bellies pushed him over the edge." They were left to grapple on their own with a lot of complicated financial theory. "We spent a lot of time building Black-Scholes models ourselves, and seeing what happened when you changed various assumptions in them," said Jamie. What struck them powerfully was how cheaply the models allowed a person to speculate on situations that were likely to end in one of two dramatic ways. If, in the next year, a stock was going to be worth nothing or $100 a share, it was silly for anyone to sell a year-long option