Wednesday, August 7, 2013

Seeing the forest through the trees: a traders view of Charlie Munger and hydrocarbons

     Years ago in the mid  1990's I was managing some derivative  traders on the American Stock Exchange and monitoring their risk . I those days there was an advantage to physical proximity to the Specialist and order flow that arrived ata certain physical spot every day. Traders stood in pits. Just like in any walk of life they often chatted even though they were most likely competitors and discussed all kinds of things usually having to do with the companies traded in their pit.
    Traders are a very different type of person. Usually self confident and independent thinkers and well educated either in the games world or at Universities..The majority of our traders were trained by us and recruited from Wharton, Columbia , Chicago and NYU. My current partner was MIT. I was lowly UConn. only a few of the traders we had did not excel at games playing and loved to think several moves ahead. Whether it was our Bridge players, Backgammon, poker or chess these games players love to figure things out. It was their strength and also their weakness.
     You see sometimes these traders , more than sometimes in fact, they got side tracked with
over-thinking a situation. A recent article in Seeking Alpha reminded me of an incident in American Airlines where I had financed a trader.

      There aren't many people smarter than Charlie Munger  so when he goes on a rant like he did recently and he clearly has a different than consensus viewpoint, its definitely worth the time to try to understand his thought process. This was exactly the kind of article that appeared in the mid 1990's and was being discussed among the half dozen or so regulars in the AMR pit. The discussion was so lively that the traders had decided and apparently they weren't alone, that oil prices could have a dramatic impact on American Airlines profitability. In this particular case concern was if oil is up then  AMR  would go down. For many reasons this was a more tenuous relationship than the traders believed.These guys were skilled in identifying "mispriced options" and  not so skilled in being securities analysts. But they were all so bright they quickly grasped many concepts and soon could repeat leading analysts research opinions verbatim. This,as would often happen on the floor, morphed into group analysis and group think.
     One morning my trader came to me worried about the exposure he had being:" net short some puts" in AMR and it was his opinion that middle east tensions could cause oil prices to rise and anyway the trend in oil prices was clearly up in his opinion. It turns out the whole crowd felt that way. But I was amazed to find out that not even a single trader in that crowd had thought to buy oil as a hedge,. They had each developed theories and interrelationships having to do with other airlines or Gold or AMR weighting in indices , all of which were ok and reasonable, but it stuck me that some of the smartest people i knew couldn't see the easiest path and the simplest hedge. The one thing they could come to complete consensus on was that oil was going higher yet none of them bought oil.From the article above I got the impression that all i needed to do was buy oil with my dollars, because over the long term the dollar value of oil is going up.The Author and Mr Munger are both quite smart but I wonder if they actually own oil? and if not what do they think is better?

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