Former trader and author of best-selling book “The Black Swan” sat down for an interview with Bloomberg News to mark the upcoming thirtieth anniversary of the stock-market crash that occurred on Oct. 19, 1987 – otherwise known as Black Monday.
Taleb famously supercharged his career – and earned a considerable sum of money (though turns out it was less than Taleb felt he deserved) – thanks to his trading profits from that day, which he said were in the “tens of millions of dollars.”
But what did he trade, and how? And furthermore, what was going through his head as he watched the market crumble around him?
Answering a question about what specific strategies he employed, Taleb explained that he relied on “tail options” – contracts that, because they were way out of the money, could be purchased for negligible sums – and placed most of his bets in “professional” markets like currencies and Eurodollar futures.
“The dollar of course collapsed. Dollar-yen options – we had options we had bought for $10,000 in inventory that were selling for 17 million.
The thing was going…it was out of control. The big payoffs weren’t in the main, big currencies, but in the ones where the move was a big surprise like Eurodollar or yen. The Swiss franc also had high volatility.”
Asked why the movements in currency and fixed income markets weren’t as heavily covered as the moves in the stock market – which is where the bulk of that day’s carnage unfolded – Taleb said it’s because these markets are strictly for professional traders. Few middle-class investors traded bonds or owned foreign currencies outright back – but everybody seemed to own stocks.
“Because it was a professional market…it was the largest market, fixed income, at the time…but only professionals talk about these things. And all the professionals that were around then are dead…Everybody talks about stocks because people invest in stocks.”
Taleb declined to disclose how much First Boston – the investment bank at which he was employed – paid him for his success that day, though he did say that, because most of his colleagues lost money, the sum was smaller than he had hoped.
“I remember the P&L. In today’s terms for the firm it would be something substantial. But at the time, compensation wasn’t the same. It was in the mid-tens of millions. I made $60, $70, $80 million in one day.
First Boston treated me very well. The problem was that it was still a common system where everybody had to share…and everybody had lost money except for me and one other fellow.”
Taleb said he vividly remembers Oct. 20, the day after the crash, when, he said, nearly all of his counterparties were outbidding his offer for his options positions by massive margins.
He specifically remembers trading with famed commodity speculator Richard Dennis, whose hedge fund went bust that day.
“I remember the [October 20], I get on the phone…and I remember there was a fellow called Richard Dennis who went bankrupt that morning at the open. There was a rally in interest rates and the guy was short eurodollars…he lost his $50 million fund…they were liquidating the thing. And I remember I had a huge delta in eurodollars. I remember then vividly offering something on the phone and filling it considerably higher. So, the guy in the pit, I’d say let’s sell here and he’d sell higher. It was like the movie trading places…all morning I remember we were selling above our offers.”
Taleb says the events of Black Monday left a lasting impression on him. His success made him brash and overconfident. But it also confirmed his view that the market’s approach to calculating risk failed to take into account the possibility of “six sigma” moves like the Black Friday crash. Indeed, that trend has only worsened with the advent of ETFs and high-frequency trading, which many market strategists believe increase the likelihood of chaotic selloffs like the May 2010 flash crash.
“After the event, I knew that all this stuff you learn in class, the Black-Scholes model, is useless…”
Asked what was going through his head when equity valuations were plummeting all around him, Taleb replies that he was so focused, he wasn’t able to process the enormity of that day’s events while they they were happening. All of his attention was focused on executing trades.
“When you’re trading, it’s like being in a battle. It’s like TV. When I’m watching TV, I don’t know what’s happening during the episode. It’s not until later that I find out. I was in a state of heightened concentration.”
It wasn’t until a colleague pointed out the magnitude of the move that Taleb began to understand that this might be a once-in-a-lifetime opportunity.
“Someone came to me and made a remark…something like don’t they know that six sigmas are something you only observe once in your lifetime?”
Indeed, it would be 20 years before Taleb would book similarly outsized profits after he joined a handful of contrarians in shorting the market ahead of Lehman Brothers’s September 2008 bankruptcy filing.
As for the extreme focus he exhibited on that day, Taleb said there have been a handful of occasions where he has had to maintain a monk-like level of focus for a prolonged period. He cited the invasion of Kuwait as one example, saying he arrived at First Boston’s office at 2 am, and remained in a state of concentration for 15 or 16 hours.
Ultimately, he says, traders are still underestimating the likelihood of another flash crash. Given the fact that realized volatility recently fell to record lows, this year’s relatively placid equity market has fostered a widespread sense of complacency in markets.
But that could all change in 24 hours’ time.
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