It was absolutely Nirvana. Futures were short-term instruments. You could be in and out of a futures contract in twenty minutes, but now 60 percent of your gain would be taxed at the long-term capital gain rate (20 percent) rather than the ordinary income rate (50 percent). How could that be? This provision defied all logic, but logic was the last thing the boys in Chicago cared about. They’d fallen into a manure pile and, thanks to Rosty, had come out smelling like the sweetest gal on the strip. Vegas might be able to offer free rooms, free drinks, free chips, Frank Sinatra, or scantily clad showgirls, but now Chicago could offer something even better, sweeter odds.
Since I’d started on the floor of the Amex, I’d made $100,000 in four months of ’79, $600,000 in ’80, and was on a million-dollar pace for ’81. I was doing real well playing stocks, bonds, some arbitrage deals that Zoellner steered my way, and, of course, options, lots of options, because options were what gave me the most leverage. I was usually in and out of a position in a matter of hours, or even minutes, so most of my profits were short-term capital gains that were taxed at the ordinary income rate. I was living in New York City and getting smacked at a 57 percent tax rate: 50 percent federal and 14 percent city and state (half of which was deductible on my federal, hence, 57 percent overall). It really hurt giving away 57 percent of every dollar I made to the government, and now, with tax straddles gone, I had to consider trading futures. Everybody who was playing big time had to consider trading futures. The ability to put 18 extra cents out of every futures dollar you made into your pocket (60 percent long-term gains taxed at 20 percent = 12 percent, and 40 percent ordinary income taxed at 50 percent = 20 percent, for a total federal tax of 32 percent rather than 50 percent) amounted to some serious money for traders.
If I wanted to trade futures out of Chicago, I had to find a clearing firm, and at this time the brokerage houses in New York still weren’t big into futures. Spear, Leeds & Kellogg was a big clearing firm that had an office in New York, so on March 2, 1982, I set up an account with them by purchasing $120,000 worth of Treasury bills to serve as my performance bond. Futures contracts have a value of fifteen to twenty times the underlying margin requirements. This meant that with my $120,000 in T-bills I could control $1.8 to $2.4 million in underlying assets. On twenty-to-one leverage, a 5 percent move against me would wipe me out, while a 5 percent move for me would double my margin value to $240,000, which would allow me to control $4.8 million in assets.
The other interesting thing about putting up T-bills as collateral was that I’d be earning interest on the T-bills while I was making money on my positions. It was the greatest game in the world. In stocks, I’d have to pay for the stock, so there was a cost of capital. In futures, there was no cost of capital as long as I was winning.
Spear, Leeds & Kellogg gave me a clerk named Debbie Horn to handle my trades. Debbie worked for David Hershkowitz on the floor of the New York Futures Exchange (the “knife”), where she had direct lines to the floors of the Merc and the CBOT. In March and April, I started experimenting with gold futures, Eurodollar futures, some of the Merc’s Swiss francs and deutsche marks, and, of course, the CBOT’s thirty-year Treasury bond futures contract. But stocks were still my game. I was making good money on the Amex trading options, and to me, currencies and bonds were like blackjack and roulette. I was looking for the craps table, which meant stocks, but there was no futures market for stocks, so I stuck with my Amex options and kept my futures trades in Chicago very, very, small. Plus, I hadn’t forgotten 1973 when I’d lost $5,000 with Paul Goldstein, the computer geek who could only afford to run his commodities trading program in the middle of the night, and another $20,000 when I’d gotten into the Russian wheat deal with Billy H., Ricky G.’s friend, the commodities broker who had a brother-in-law who supposedly had a direct line to a guy in Washington who knew a guy at the Department of Agriculture who’d been to Moscow….
Another reason I couldn’t focus on futures was that in November of 1981, my personal life suffered a major setback. Audrey was twenty weeks pregnant with our first child, but when she went in for amniocentesis, the doctors discovered that there was no amniotic fluid and that we would soon lose the baby. We were devastated. My grandfather Pappy Snyder used to like to sing the line from South Pacific that went “If you don’t have a dream, how you gonna make a dream come true?” but what Pappy never told us was how much it hurt when one of your dreams was taken away.
After Audrey lost the baby, we said the heck with it, life was too short. Why was I making all of this money if we couldn’t enjoy it? It was time to spend some. Audrey and I had always taken shares in group beach houses—in fact, that’s how we’d met—but now that we were married, we were stuck in a two-bedroom apartment in New York with no place to go. It was like living in a cage. We’d always wanted to have our own beach house, so we decided that it was time to get ourselves one. As of January 1, 1982, we had a net worth of $1.2 million. We took one-third of it, $400,000, and bought a beach house out in Westhampton.
Financially, putting that much working capital into a non-working asset was stupid. It took a big chunk of money that I should have been trading out of play, but I had this image of myself out at the beach for three months during the summer, wheeling my Quotron machine outside, sitting next to the pool trading every day. (I subsequently found out that the glare out by the pool was too tough and I had to wrap a towel around my Quotron machine and climb under it like Matthew Brady.) Plus, given my success over the past three years, I was sure that I could always make more.
When I got knocked down, I never took the eight count. I always got right back up because I was a firm believer that when something went bad, something good would be coming along, and if I was still lying on my back, I’d miss it. I was on my feet on April 21, 1982, two months after we’d bought the beach house, when the Merc launched the Standard and Poor’s 500 Stock Index Futures Contract, a new financial instrument that Leo Melamed labeled the “ultimate contract.” And it was. The S&P futures contract was based on the stock price of five hundred large-cap companies. Right away, I could see that the S&Ps were going to be my game because they were based on stocks. All the techniques I had developed or synthesized, the Magic T, the ten-day moving averages, the oscillators, the stochastics, were geared toward playing this new instrument. It was like I’d been playing at the dollar blackjack table, and all of a sudden, they opened a craps table with a $10,000 limit.
On the morning of April 29, 1982, I made my first S&P futures trade. I bought twenty June SPMs and lost $370. The next day, I tried again. I bought forty June SPMs at 117.20. An S&P futures contract was priced at five hundred times the value of the index being purchased, in this case June SPMs. So the value of these contracts totaled $2,344,000 (40 × 500 × 117.20), but I didn’t have to put up any money because my $120,000 in T-bills was enough to cover the margin requirement. This was leverage, baby, real leverage. After a couple of hours I sold out at 117.70 and made $10,000 (40 × 500 × 117.70 = $2,354,000 less my cost of $2,344,000).
All that spring and summer I kept experimenting with the S&P futures. While I was intrigued by the S&Ps, I was still cautious. All new instruments are unpredictable. When they first trade, everybody’s trying them out, the volumes are erratic, and it’s tough for the exchanges to maintain orderly markets. What I’d do was divide the trading day into half-hour blocks, just like the Merc did, and each half hour, I’d chart the rate of change. I viewed momentum during the day just like the tides, two high and two low, ebb and flow, back and forth. If the S&P 500 composite index was up $0.50, then up $0.30, then up $0.10 in three consecutive blocks, then I knew that the momentum was shifting. The sine curve was about to turn down, the market was coming to a stoplight, it was time to switch gears. Red light, green light, go short, pull the trigger.
I saw lots of possibilities for the S&Ps. In addition to having phenomenal leverage and having the ability to get quickly invested in the market without having to buy a whole portfol
io of stocks, the S&Ps were a fantastic hedge. If I thought that the market was going down and I didn’t want to sell my stocks because I didn’t want to lose my holding period, I could sell an equivalent amount of futures contracts against them to try and net out some of the risks. And there were all sorts of tax advantages that were just starting to evolve.
But I was still playing small, because in August, Paul Volcker, the chairman of the Federal Reserve Board, had given the market a jump start when he called the big bankers at their vacation retreats in Martha’s Vineyard, Jackson Hole, Bar Harbor, Newport, and the south of France and told them to come to Washington. Rumors were floating around that Mexico was about to default, and at the meeting in Washington, the Fed decided to reliquefy Mexico so that the big U.S. banks wouldn’t go into the tank. On that news, interest rates started to drop, and bank trust departments, pension funds, mutual funds, and insurance companies that had been parking huge percentages of their assets in money market instruments with yields as high as 18 percent started to come back into the stock market. On August 17 the Dow Jones rose a record 39.81 points, and I was too busy whipping my options to fool with S&P futures.
Plus, I was making money trading currencies and Professor Sandor’s thirty-year T-bond futures. Thanks to Rosty’s little miscellaneous provision and the fact that the government was issuing more and more debt, Eliza Doolittle was looking better and better to a lot of heavy hitters, and the CBOT’s thirty-year T-bond was becoming the world’s most actively traded futures contract. This increased volume made the T-bonds a safer bet.
I’d also discovered a new tool, a quote machine called the Telerate, that was really helping me play the T-bonds. While the CBOT was maintaining an orderly market for the T-bond futures, there was no centralized market for the “physicals,” the actual bonds already issued by the Treasury. The physicals were the crops in the silos, and they were being bought and sold by the individual farmers, investors, and institutions trading through brokerage firms. As interest rates went up and down, the price of the outstanding physicals would go down and up, but one firm might offer a bond at 101 while another firm was offering the same bond at 98. It all depended on who had what bonds and how much they wanted to buy or sell. Like farmers buying and selling silage, trades were made by calling around trying to find the best price.
Neil Hirsch, a former bond salesman with Cantor Fitzgerald, had recognized the need for a black box service that would list the prices for all of the “physicals” in one place. Hirsch started a company called Telerate. Hirsch’s company called around to the different brokerage firms and got up-to-the-minute quotes on all of the different bonds that the Treasury had issued. These quotes would immediately appear on a black box that bond traders could rent from Telerate. It was a simple idea that made Hirsch a very rich man. He ended up selling Telerate to Dow Jones.
Not long after I started spending more time upstairs from the floor of the Amex, I got a Telerate. Everything in this business is about finding disequilibrium, that’s what produces opportunity, and I knew that the Telerate would help me play the bond futures. Plus, I loved gadgets and was always buying anything that was new. Even though I was working from upstairs, the Amex had a rule that members had to physically make an appearance on the floor every day. I used to go down to the floor every morning, but because the Amex traded stocks, not bonds, there was not a single Telerate machine on the whole floor, so I’d always head back upstairs around three o’clock to check the bond quotes on my Telerate. The bond futures market closed at 3:00 P.M., but the physicals traded as late as the brokerage firms wanted to trade them, and thanks to my Telerate, I could get a feel for how bond futures would do the next day by monitoring the cash bond prices in the after-hours trading.
On Friday afternoon, September 10, when I came up from the floor to check my Telerate, I noticed something interesting. “Audrey. Come look at this,” I said. “I think that there’s a correlation between the cash bond and the S&P 500.”
“I’m busy, Buzzy,” Audrey said. After it had become obvious that I was going to make it as a trader and we’d decided to start a family, Audrey had quit her job at the American Paper Institute and come to work with me. She’d do my charts and my paperwork and listen to me talk about the market. Before too long, she could tell whether I was serious about a trade or was just trying to talk myself in or out of something.
“No, come take a look. I think I might be on to something.”
Audrey was doing paperwork and didn’t want to be bothered. We’d just moved back to the City from the beach house that week and she was catching up. Reluctantly, she wheeled her chair over to where she could see the Telerate. “I’ve been looking at the cash bonds as an indicator for the bond futures,” I said, pointing at the quotes, “but, you know, stocks also rise and fall on interest rates.” That’s because when interest rates go up, companies have to pay more for their capital, which increases the cost of doing business and cuts into their profits. And higher interest rates make it more difficult for consumers to buy on credit, which slows down sales and cuts deeper into profits. Lower profits mean lower stock prices.
“So?”
“So, if the T-bonds go up in the after-hours trading, that means interest rates should be going down the next day, which means the S&Ps should open up.” I grabbed a handful of charts. “Let me give you an example. On August thirtieth, the price of the physicals broke down three-quarters of a point in the last hour.” I took out the chart with my ten-day moving averages. “Here, look at the S&P index on the thirty-first. It opened down 0.80. But here last week, the bonds ticked up half a point. And look, the S&P opened up 0.65 the next day.”
“So?”
“Audrey, this could be a great indicator!” I was getting excited. “The bond futures close at three, but the S&Ps don’t stop trading until four-fifteen. If the physicals go up between three and four-fifteen, I can buy futures right at the close. If they go down, I can sell the S&Ps short.” I pointed to the quotes on the Telerate. “Look, the bond price has moved up half a point in the last hour. If I’m right, that means that the S&P should be up on Monday.”
Audrey checked her watch. “Buzzy, it’s four-ten. You’ve got five minutes. If you want to give it a try, give it a try.”
I was already reaching for the phone. “If the bonds are up half a point in the last hour, I might be too late. I gotta check the S&Ps…Debbie! Debbie, honey,” I said to Debbie Horn, my clerk at Spear, Leeds & Kellogg. “Yeah, Marty here. The December S&Ps! Gimme a quote, I need a quote. Beautiful! They haven’t budged. Get me thirty contracts at the market.”
All that weekend I pored over my charts, trying to correlate the price of the physicals in after-market trading with the opening price of the S&Ps the next day and to see how that matched up with my other indicators. It wasn’t perfect, but most of the time, significant after-hours moves in the cash bond resulted in similar moves in the S&Ps the following day. More important, these moves fit right into the patterns established by my primary indicators: the Magic T, my ten-unit exponential moving average, my oscillators and stochastics.
I couldn’t wait for the market to open Monday morning. Audrey and I got in early and I sat glued to the Quotron. I was sure that the market was going to open up, and it did, at 119.40. “Yes!” I picked up the phone and called Debbie. “Sell!”
For the rest of that week, the after-hours trading of the cash bonds was inconclusive, down 3/32 one day, up 2/32 the next. It wasn’t until Monday, September 20, that my cash bonds indicator made a significant late move, up 9/32. “Okay, Audrey,” I said, “this is it. The S&Ps should open up tomorrow.”
“How much?”
“I dunno. I’ve still gotta work that out. I don’t have enough data yet. But believe me, those babies are gonna open up, at least 0.20.” I picked up the phone at 4:10. “Debbie! Gimme a quote on the December S&Ps…123.40…Okay, load me up. Buy me a fifty lot at the market.”
Debbie called back at 4:11 and said that
I was filled at 123.45. What I’d done was to buy fifty contracts at a theoretical cost of $3,086,250 (50 contracts × 500 × the value that the marketplace was predicting for the S&P index in December 1982). But once again, I didn’t have to put up any cash, because the T-bills in my performance bond account covered my margin requirement. On Tuesday, they opened up 123.65 and immediately ticked up to 0.75. Bingo, an instant paper profit of $7,500. I checked all my other indicators. Everything was pointing up. “What should I do? Audrey! What should I do? Should I take the profit or buy more?”
“Buzzy, just hang in there. They opened up so now you’re playing with the house’s money.”
The S&Ps ran straight up to 124.40 before they stopped to take a breath, and I bailed out at 124.30 with a nice gain of 0.85 and a profit of $21,250. This was all right. Being ahead at the opening was like waking up with a woody. What a way to start the day. That same afternoon, the physicals jumped another 11/32 in after-hours trading, so again at 4:10 I went long fifty more contracts, and when the S&Ps opened up 0.70 I was up $18,750. Beautiful!
On Thursday the twenty-third, the physicals hit a downdraft in the after-market and gave back 12/32. Now it was time to test the other half of the equation. “Debbie! How’re the Decs? 123.85. Sell me twenty-five short.” I glanced over at Audrey. She was nodding. “No, screw it. Make it fifty, short fifty contracts at the market.”
At 10:01 the next morning, ding! the register rang up another $18,750 as the S&Ps opened at 123 even. Yesss! AC/DC, it worked both ways!
For the rest of September, I kept sparring, jabbing, punching, counterpunching, long a fifty lot here, short a fifty lot there, poking, all the time playing off my Telerate. The market overall was going nowhere. The S&Ps opened at 119.40 on September thirteenth and closed on the thirtieth at 119.35. But I was up $160,000 on small daily swings.
Pit Bull Page 10
