Lesson learned from Jamie Mai and Charlie Ledley of “The Big Short”
Early 2003, Jamie Mai and Charlie Ledley, a pair of thirty-year-old men, Cornwall Capital Management, Schwab account containing $110,000, neither had made actual investment decisions, they decided, would not merely search for market inefficiency but search for it globally, in every market: stocks, bonds, currencies, commodities.
Their 1st big opportunity, a credit card company called Capital One Financial, they studied the business, reports, news of scandal, interview all sorts of people including company VP, then bought two year LEAPS at $40 with $3 (stock price was $30 by that time), they invested $26,000 (about 23.6% of their total portfolio) in the LEAPS, and soon, Capital One is vindicated by the regulators, their investment of $26,000 became $526,000.
Their 2nd opportunity: distressed United Pan-European Cable, they bought $500,000 LEAPS, struck at a price far from the market, when UPC rallied, their investment of $500,000 became $5,500,000.
3rd opportunity: bet on a company that delivered oxygen tanks directly to sick people in their homes. their investment of $20,000 became $3,000,000.
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 to buy the stock at $50 a share for $3. Yet the market often did something just like that. The model used by Wall Street to price trillions of dollars’ worth of derivatives thought of the financial world as an orderly, continuous process. But the world was not continuous; it changed discontinuously, and often by accident.
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
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.”
4th opportunity: Event-driven investing – ethanol futuresTwo years after they’d opened for business, they were running $12 million of their own and had moved themselves and their world headquarters from the Berkeley shed to an office in Manhattan–a floor of the Greenwich Village studio of the artist Julian Schnabel.
then bet in subprime loans
Something to learn from Big Short’s Jamie Mai
Cornwall seeks highly asymmetric investments, in which the upside potential significantly exceeds the downside risk, across a broad spectrum of strategies ranging from trades that seek to benefit from market inefficiencies to thematic fundamental trades. The firm has produced an average annual compounded net return of 40 percent (52 percent gross).
From “The Big Short_ Inside the Doomsday Machine” by Michael Lewis Posted by Timeless Investor