The following excerpt is taken from the new book “Life In The Pits: My Time As A Trader On The Rough-And-Tumble Exchange Floors,” by Brad Schaeffer (Post Hill Press, December 2023)
The Big Dog And The Fox
You have to work pretty hard to lose almost $7 billion in a week.
Brian Hunter managed to do just that. Although he was coldly indifferent to the devastation his activities had wrought, it was an agonizing experience for Amaranth’s remaining investors, such as county pension funds representing teachers and public servants and others far removed in both geography and understanding of what was happening to their quickly evaporating money. But, once again, as seems to be the mantra of the trading and brokering business, their pain was our gain. The day after Hunter flew back from a golf outing, for example, the hosting broker received a call calmly instructing him to sell tens of thousands of one-year-out strips of call options. And these phone calls and instant messages from Hunter and his assistants were going out all over the broker community. One broker was paid a million dollars in fees for one day’s work … somehow, even though the fund lost billions, they managed to scrape together the money to pay the commissions.
As lucrative as it was to be a broker in the Big Dog’s pound, being one of the traders on the other side of Hunter’s epic collapse was a far better deal … if you had the deep pockets and diamond-hard testicles to stay the course in the face of his attempts to artificially squeeze you out of your fundamentally correct position in natural gas spreads and other derivatives by relentlessly buying and pushing the market up in your face until you were compelled by margin calls to turn the paper loss into a real one. This happened to one well-respected fund manager who got the trade right but entered just a little too big and a tad too early to withstand the paper losses he was incurring due to Hunter’s Banzai charge of nonstop buying, especially of the March/April spread, known in energy trading circles as “the widow-maker” for its propensity to gyrate wildly with the slightest weather events. Eventually the fund manager’s investors couldn’t take the heat and bailed on him, forcing him to buy back his shorts and lock in his losses in a liquidation to meet a wave of redemptions.
Down in Houston, John Arnold was also taking heavy paper losses as Hunter dug his own grave deeper and deeper by buying gas that no one with any fundamental understanding of the supply/demand dynamic in play would want anywhere close to these inflated prices once he stopped his artificial short squeeze. But Arnold had made his investors a mint already, and they’d learned to trust his judgment. So the ever-calm trader patiently waited for Hunter’s inevitable tumble from the mountaintop once he ran out of bullets and had to turn around and offload his position … to no one. When Amaranth initiated a fire sale of their non-energy positions just to meet Hunter’s rising margin calls, The Street knew there was blood in the water.
The besieged Canadian’s problems only worsened when on August 29, 2006, the expiration day of the September 2006 contract, he decided to make a huge play by selling more of the September futures and buying the October throughout the course of the day. Since he owned the more expensive leg, he was effectively long the September/October spread starting at 36 ticks October over. By noon, his selling of September and buying of October had pushed the spread to as wide as October trading 50 over September … meaning what Hunter was short (September) was falling more than what he was long (October). The trade was moving in his favor. Or, more correctly, he was muscling it his way.
Given the sheer size Hunter was trading, he inevitably widened the differential between the two months, which in turn prompted him to pay higher and higher prices to keep it moving in his favor. He was caught in a vicious cycle. Still, he figured that, as the September contract would expire in a few hours, he might just run out the clock before any correction occurred. By 1:30 p.m. that afternoon, the September futures had only one hour left until it expired and so its settlement price would be locked in place. Hunter could then sell out his long October position, which wasn’t set to expire for another month, and be flat, with a tidy profit. All would be well…at least for this day.
That’s when Arnold made his move. He sensed from the sudden slowing of trading activity that Hunter had run out of ammo and thus was no longer able to hold his September shorts down relative to the long Octobers to protect his massive bet. This was due to trading limits and the already enormous size of his other positions relative to his total capital. (In some months Amaranth held over half of the total amount of open interest on the exchanges…”open interest” meaning the number of contracts or commitments outstanding in futures and options that are trading on an official exchange at any one time.)
Arnold, however, had a deeper reservoir of money, along with a fundamental conviction, based on both weather forecasts and gas in storage going into the end of summer, that the spread should be closer to flat than October trading a full fifty cents over September. So once Hunter was done, with less than an hour to go before the contracts expired, Arnold swooped in and bought thousands of September futures … the very ones Hunter was short and needed to stay low into expiry. His quiver now empty, the Big Dog could only watch helplessly as his enemy — for he saw Arnold as his chief rival — pushed up the September contract in his face with a torrent of unrelenting buying. By the time the clock hit 2:30 p.m. and the September contract’s final settlement was posted, the spread, which had shown Hunter a hefty profit when it was trading at $0.50 to the October just forty-five minutes before, settled at a mere six cents. Arnold had crushed him.
This one episode cost Amaranth another $600 million. Hunter fumed, insisting that he was the victim of market manipulation. But no. He was just on the losing end of a battle he initiated. In short, his ego was now writing checks his dwindling account could no longer cash. The market knew that he was in a bind. And they had no interest in letting him out without a serious, even fatal, exit toll.
Finally, inevitably, with the March/April spread steadily collapsing in the face of a serene winter outlook, once again earning its ominous “widow-maker” sobriquet, with his losses in other overleveraged positions across the board mounting, it was time for Hunter to shut it all down and pay the piper. But his inventory of futures and options was so colossal that there was no way he could ever trade out of them piecemeal. The market would eat him alive. As such, Hunter’s last hope to offload his enormous portfolio that stretched out for years along the curve was to find someone willing to buy the entire decimated book in one trade. It was the only way Amaranth could raise the funds quickly enough to meet its multi-billion-dollar margin calls from anxious clearing firms. In desperation, Hunter went directly to the victorious Arnold—whose inventory of futures and options was the opposite of the defeated Canadian’s now-hemorrhaging natural gas book—and asked him to name a price to take it all off his hands. The bid Arnold showed was both reasonable and devastating. The taciturn Texan was telling Hunter in no uncertain terms that without his artificially moving the market where he wanted it to go, this was the true value of his depleted book. Take it or leave it. Hunter left it.
As it turned out, another hedge fund, Citadel, and the energy trading group at J.P. Morgan took Amaranth’s losing positions onto their books for a slightly better price than Arnold had shown, if still at a crushing discount. The giant one-off transaction stopped the bleeding. But Amaranth, the once admired hedge fund whom their rogue trader had brought to its knees, was forced to shut its doors for good. There were at least no market repercussions as it was an orderly and contained unwind.
When the hedge fund/IB duo made its final price for buying what remained of Hunter’s demolished position to close out his trades in one massive asset transfer, the losing trader chafed at the great “deal” the buyers were getting at his expense. “Brian was right; it was a good deal for us,” said my Citadel client, who was one of the hedge fund’s chief traders assigned to take the book onto their balance sheet. But he reminded Hunter that “maybe you shouldn’t put yourself in a position to hold a fire sale to begin with.”
After grudgingly accepting the terms of the position transfer — thus locking in what was at the time the largest loss suffered by any single trader in Wall Street history — Hunter asked the Citadel trader with a hint of irritation at surrendering his massive portfolio that had defined him for two years: “You sure you can handle a book this size?” My customer, a math whiz, and as humbly brilliant as the man chafing on the other end of the phone was patronizing, was honest. “No,” he said, “I’ll just have to do my best.” And though he was above ever pointing it out, the irony of the question considering who’d asked it was self-evidently astounding. It certainly showed that even at the very end, after he’d destroyed a business that others worked years to build, and sent investors across the country reeling, he never lost his sense of who he was … the biggest monster trader to ever sling natural gas. He also was finished in the industry.
As for John Arnold, who’d won the game of high-stakes chicken, Reuters reported that in 2006 his fund returned over 300 percent net of fees. He’s retired now and doing charitable work with his Matterhorn-sized pile of money. Well played.
Interesting side note. Although Hunter’s 2006 losses eclipsed the $4.6 billion lost by bond-trading guru John Meriweather’s hedge fund Long-Term Capital Management (LTCM) in 1998, which had been the most sizable nonfraud-related trading loss in history up to that point, astoundingly just two years later, the Big Dog himself would be dethroned as trading’s single biggest losing individual. This accomplishment was courtesy of a relatively unknown credit default swaps trader at the staid white shoe investment bank Morgan Stanley. Howie Hubler managed to sacrifice an astounding $9 billion to the gods of the market, albeit real quiet-like. To my knowledge, all of these men who had, as the phrase went, “blown up their books” managed to walk away from their debacles with tens of millions. Wall Street is one of the only businesses wherein over the course of your career you can be a net loser and still come out on top. I liken it to an architect who may have designed a house or two that stayed up nicely but then designed a skyscraper that came crashing down and still walked away from the rubble with millions. Nice work if you can get it.
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Brad Schaeffer is a commodities trader and author. He has been featured in the Wall Street Journal, New York Daily News, National Review, The Federalist, The Hill, The Daily Wire, and Zerohedge among others.
This excerpt is taken from “Life In The Pits: My Time As A Trader On The Rough-And-Tumble Exchange Floors,” by Brad Schaeffer. Copyright © 2023 by Brad Schaefer. Reprinted by permission from Post Hill Press.
The views expressed in this piece are those of the author and do not necessarily represent those of The Daily Wire.