'No one is bigger than the market' - A lesson it appears the 'The Whale' may have forgotten.

We hear this morning that a man by the name of Boaz Weinstein was the driving force behind hastening the demise of the 'London Whale'. Weinstein runs Saba Capital Management a hedge fund based in New York. Weinstein is a renowned index arbitrageur, he was the apparently the main (though probably not the only person taking on Iksil) in the CDS markets.- Effectively, Iksil was taking on the arbitrageurs, a plight tried by many people, but rarely (if ever) won, I will explain why.

Arbitrage is a word commonly understood as being the ability to take advantage of minor price differences across markets or products. -  I.e. At its most simple to buy Asset A at one price in one market and sell Asset A simultaneously at a higher price somewhere else. - This is the holy grail sought by many banks and large hedge funds who have the ability (capital, resources and infrastructure) to be able to do this. - As one would expect the differences are usually very small and usually exist very briefly, one has to be able to do it in huge size and very rapidly to make it worthwhile, and indeed in the highly liquid markets arbitrage rarely exists, if it does occur, it is very quickly 'arbed' away.

Pure arbitrage, of the form described above, is really a thing of the past, though times of extreme market disorientation can still throw up the odd opportunity. However arbitrage still exists in less liquid and more opaque markets. - Most Investment banks (and many hedge-funds) have teams of 'relative value' traders, looking for and trying to take advantage of arbitrage opportunities or near arbitrage opportunities, between products of a similar nature where a fairly consistent relationship exists. 

In my early days in the markets I worked in the emerging field of derivative arbitrage, trying to takes advantage of the relationship between yields and the forward fx markets. I had two memorable occasions where I came up against traders inside large banks who thought they could take on the arbitrageurs and win, much to their cost:

- The first occasion was in 1989, I was working at a small Norwegian bank in London at the time, where I was active in the markets looking for arbitrage opportunities. This was the time of the collapse of the Berlin wall and German re-unification, the fears at the time were that this would lead to much higher German yields. One particular trader at a large US bank in Frankfurt stood firmly against this move to higher yields, he was on the offer on the German yield market in all maturities up to 2 to 3 years, however the much larger and more liquid forward Foreign Exchange market were producing bids on yields on German instruments greater than his offer levels. - I did not have a view on German yields or Foreign Exchange rates, but it was almost rude not to pass up the opportunity for near risk-free profits by lifting his offers and executing the arb. Fellow arbitrageurs at other banks, including notably one large Dutch bank and another large US Bank, were in on the same trade. - Still the banker at the US bank in Frankfurt sat on the offer refusing to budge, ironically offering even more profit as the synthetic bid from the forward fx market was now even greater, this not only encouraged us arbitrageurs further, it brought in other participants to the trade. - Effectively the Frankfurt banker was overcome and had to pull his offers, the market's had 'boiled-over' him, and eventually this banker was beaten - a spent force. - The irony was that the Frankfurt banker was ultimately proved right, but so big was his position, and so firm was he trying to fight the market, that he was forced to cover, which actually forced the market further against himself at that time of covering his positions. - If memory serves me correctly, yields have never been up there since.     


- The second occasion was a few years later, I had progressed in my career and was now working for a large Swiss bank in London. One of the markets I was actively arbitraging was the ECU (European Currency Unit, the forerunner to the EURO)

At the time I was noticing that the same bank (another large Swiss bank) was opposite me on every trade. - Which meant one of us was wrong. - I happened to know that the other bank was doing the ECU basket trade, buying or selling the ECU basket and doing the opposite in the currencies which were the component of the basket. It was one arbitrage meets the other. - Having done this for around 8 years on the same formula I knew my method was correct, which meant basically that my counterparty to all these trades was basically miscalculating the basket. - Sure enough a few months later some rather large discrepancies started showing up in that large Swiss bank's trading accounts (A bank by the way that has not been immune from similar though much larger problems in recent times).

I relate this back to the unfortunate 'London Whale' because this sounds all too familiar. The instruments may have changed, they are certainly far more esoteric, but in the early days of derivatives, perhaps the instruments I traded, which would be considered part of Trading101 now, may have been considered esoteric by many. - In this instant the very bright and astute Boaz Weinstein spotted the opportunity to buy CDS instruments at a very good discount to the basket of the instruments they were suppose to be hedging, this stopped Iksil from being able to bully the market his way. I suggest that this may have irked Mr Iksil enormously, who despite being a low profile and very private person, would possibly have felt his pride and ego hurt that he was unable to force his will upon the market, and so engaged in even more trades, all of which further lined the pockets of Mr Weinstein and fellow arbitrageurs. This whole situations sounds akin to the example of the Deutschmark trader above, though in far larger size and with a far more devastating outcome.

My years on this planet are littered with failed attempts of one kind or another to take on the markets and win. Amongst some of the more well known ones are the Hunt Brothers and Silver, Hamanaka and copper, Nick Leeson, LTCM, Porsche and VW shares, Armarajo and cocoa, to name but a few. I am sure there are many mini and micro attempts going-on in markets constantly, I believe these contribute to the price action and volatility in the markets. - The moral of the story however is; it does not matter how big you are and how much power you have, you can not fight the market and hope to win, no one can bully the markets, and no one can bend them to their will.

Note : Image "Trader" by Vlado, courtesy of FreeDigitalPhotos.net.