Soros’ Worst Trade

There is this Canadian rock star who retired a few years back and took up hosting an afternoon drive-home radio show on a local Toronto station. Sometimes his program includes a segment called, “Damn! I wish I wrote that.” This ex-rock star will play a famous song on his guitar, tell the story of how it came to be, and then end with his great tagline.

Well, I am stealing his idea with my own segment called, “Damn! I wish I traded that!”

And for the first episode of DIWITT, I present the story of George Soros’ worst trade…

In 1987 George Soros was hardly a household name. He had yet to break the Bank of England, and although highly regarded within the small group of Wall Street traders who covered hedge funds, these types of clients were still relatively unknown.

Yet George was still a player who swung a big bat – especially in the burgeoning financial futures market.

In 1987, Soros was convinced the world’s stock market were vulnerable to a correction, but mistakenly forecasted the crash would emanate out of Japan. After all, Japan seemed most bubblicious, and Soros thought the Nikkei’s meteoritic rise was unsustainable.

George put on a large short Nikkei / long S&P 500 futures position. The trouble was, Soros got it wrong. The Nikkei still had a couple more manic years of rising ahead of it, and the ‘87 crash started in the United States instead of Japan.

How did George manage through this period with his large position? After all, US equities suffered their worst one day decline in history.

Let’s have a look at the chart of the S&P 500 futures contract during this volatile week. When you look at the following 5 minute chart, and see how the S&P 500 contract was down almost 80 handles on the day of the crash, it easy to be fooled into thinking it might not have been that bad. But you need to remember that the S&P 500 closed at 281.50 on Friday. So Black Monday’s decline on October 19th, 1987 would equal almost 700 points in today’s market. We are trading at 2,460 as I write this, so imagine a crash tomorrow that sends the spooz down to 1,750 in a single session!

Many of us know the story of Friday’s decline that was celebrated by some as the end of the correction, only to be followed by Monday’s gap down and the accompanying collapse. Then Tuesday’s attempted rally that failed, with the scary push down to a new low. Finally, Wednesday’s big gap higher that managed to hold all day.

But how many remember Thursday’s open? Have a look at the monster gap down. The difference between Wednesday’s close and Thursday’s open was over 22%!

That story is not well known, and is the subject of today’s DIWITT and is a trade that Soros would most likely like to forget.

I am not going to tell the whole story, but take snippets out of a couple of books to tell the tale. The first is Tim Metz’ Black Monday. Before we start, you might be confused when the author talks about “cars.” Cars refer to contracts because at one point, contracts were often the amount that would fill one railway car. It was something particular to the CME and seldom used at the CBOT. Often, it gave away a trader’s background. Anyways, on to the story.

October 22, 1987. Chicago Mercantile Exchange trading floor, 9:30 A.M., EDT: The price voltility in the pit has seemed to lose its rhythm and any semblance of predicability, with this terrifying exception: The word has spread everywhere at the CME this morning that Shearson Lehman Brothers plans to sell thousands of cars on today’s opening.

Scott Serfling almost stayed too long in his upstairs office and he had to run for the elevator to make it to his trading desk on time. But he is here now, and today’s opening will burn in his memory:

“Shearson’s floor broker offered 6,000 cars on the opening. Nobody would say anything [that is, make a bid]. Finally he got a bid of 198, down 60 points from Wednesday’s close. And he took it. Then he sold 8,000 more cars in the first minute of trading. It had to cost them $300 million to do that. And then, in another minute and a half, the price was back up to 230,” he will remember.

Serfling’s memory will be amazingly accurate, the Brady Commission report confirms. Noting that the contract opened “an unprecedented 60 points lower,” the Brady report will explain that:

“Apparently it became known in the pit that there was a large customer order to sell several thousand contracts, and given the uncertainty of the market, many of the locals backed away. However, beginning suddenly at 9:30 A.M., the futures began to rally sharply, reaching the 230 level within three minutes. Approximately two hours later, the S&P futures were back above 250.” It was an instant 24% decline followed by a 28% rally in two hours.

Goldman Sachs bought some of the contracts at the opening, Bob Rubin, the firm’s top trading official will confirm.

So did Shearson, acting for its own account, another official will confirm. “I was mad as hell when I found out it was one of our own customers’ sale,” he will add. The seller was high-stakes Wall Street investor, George Soros. “You ought to talk to George about that trade, if he’ll talk to you,” Rubin suggests. But attempts to reach Soros will be unavailing.

The incredible bust will be a miracle that changes the life of one of Sterfling’s local colleagues, who on Wednesday, yesterday, mistakenly neglected to close out a short position of twenty-five cars. The mistake could have been a disaster if the market had opened sharply higher.

Instead, the price break caused by Shearson’s selling will let him buy the twenty-five contracts he needs at less than 200, giving him a profit of “$700,000 to $800,000. I only knew him by badge number and he wouldn’t talk about it. He just walked out the pit, sold his seat, and he hasn’t been seen back on the floor since that day,” Sterfling will recall.