Three Trades That Changed Everything

From Mark Cuban’s billion-dollar collar to The Big Short’s crash puts and Barings Bank’s historic collapse, these are the stories that defined modern trading. Veteran options trader Mat Cashman joins Andrew Wilkinson to unpack the strategies, the risks, and the timeless lessons every trader should know.

Summary – IBKR Podcasts Ep. 305

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Andrew Wilkinson 

Welcome to today’s podcast. My name’s Andrew Wilkinson from Interactive Brokers. Today’s episode is a special one. We’re calling it The Three Best Trading Strategies You’ll Ever Hear—and What They Teach You About Options. And to help tell those stories, I’ve got the perfect guest. He’s a veteran trader, a teacher, and someone who knows what it feels like to have the market breathing down your neck—Mat Cashman. Thank you for joining me. 

Mat Cashman 

Andrew, I am so happy to be here. Let’s roll up our sleeves and tell some war stories, my friend. 

Andrew Wilkinson 

Okay, let’s do it. Story number one is about getting paid in stock, not cash, back in 1999—and deciding you’d like to keep that money. Reveal all, Mat. 

Mat Cashman 

I shall reveal, Andrew. I want you guys to picture it—it’s April of 1999. Someone that most people know: Mark Cuban. Now, we’re talking about the same exact person, but not the same person you know today. He was a different person. He had just started Broadcast.com and sold it to Yahoo, which was the big, high-flying stock at the time. 

The price tag for this deal was $5.7 billion. Now, it was in Yahoo stock. An interesting little tidbit about this—Cuban’s personal haul on this deal was $1.4 billion. Now, there’s a catch. He cannot sell his stock because of a lockup that’s built into the deal. And the late ’90s tape was, let’s just say, it wasn’t exactly a calm market. I was trading during that time, and it was absolutely bananas. So, what do you do when your entire net worth is in one stock—and it’s in the wildest market you’ve ever seen? You collar it, Andrew. You trade a collar. And Mark Cuban, through Goldman Sachs, structures a zero-cost collar. He buys puts below the market where the stock is trading, sells calls above the market where the stock is trading. The premium from the calls that he takes in offsets the premium for the puts—that’s why it’s called a zero-cost collar. 

And now his lottery ticket that has just paid off is a defined payout instead of a long-only bet. So Yahoo was about $170 when the deal closed. He bought the 85 puts through the zero-cost collar, sold the 205 calls. He basically said, “I’ll give anything up above 205 to make sure that we don’t fall through 85.” And that makes this engineering, not gambling—and that’s why we’re talking about this in terms of options today. 

So, Andrew, do you remember what happened? 

Andrew Wilkinson 

I remember there was a chart of Yahoo on the front of the FT around April 2001, a couple of years after this, and it was showing Yahoo was worth more than ExxonMobil. Take it from there. 

Mat Cashman 

Indeed. So what happened was—he sells, remember, the 205 calls; he buys the 85 puts. Stock rips all the way through the 205 calls, goes up to 400-plus, and then spends a little bit of time there—just a tiny bit of time—and it implodes into the teens. Goes through those 205s, all the way down through the 85s, all the way down into the teens. Cuban, of course, because he had a collar on, walks away with his billions locked up. And that was the beginning of the Mark Cuban you know today—the previous owner of the Dallas Mavericks, Shark Tank investor, the whole nine yards. But that’s where it all started—and how he used options to do it. 

Andrew Wilkinson 

So Mat, from a Greeks perspective, that’s long downside gamma from the puts and short upside gamma from the calls—netting into a fixed outcome band, right? 

Mat Cashman 

Absolutely. That’s a great way to put it. And when you’re trading in a pit—and if I were trading in the Yahoo pit at the time (I wasn’t trading in the Yahoo pit at the time)—but when something like that hits the tape in a pit, and is traded on the listed options, you actually really feel it. You feel it hit in front of you, because things like the skews bend. The upside vols get really heavy because there’s someone in there selling a bunch of upside calls—those 205s that he had to sell in order to offset the 85 puts that he was buying. Clerks run around, running tickets all over the place, like the house is on fire. That is the sound of someone buying themselves a floor against their actual long underlying position. 

Andrew Wilkinson 

Very smart, very shrewd. 

Mat Cashman 

Yes, very shrewd. And like I said, the beginning of Mark Cuban’s long, storied career in investing. So, collars—the takeaway I want people to have here—is that collars are a great way to hedge concentrated stock positions. They give you a way to trade hope for certainty. They give you a defined outcome in a situation that might not have a defined outcome before that. 

Andrew Wilkinson 

Alright, story number two’s a big short with an options twist. Let’s go to the mid-2000s, and a handful of traders think that the housing market is rotten to the core—despite the fact that it’s going up like crazy. Mat, walk us through what they did. 

Mat Cashman 

So, many of you either may have traded during this time or may have been reading financial news around this time. You may remember someone standing up on one of those trading desks with a shirt that said, “I’m short your house.” And this is how they did that. 

So, they can’t actually short your house—but they can short the credit that is tied to it, and that is lumped up in tranches with all the other mortgages. So, they go out and they buy credit default swaps, or CDSs. Basically, credit default swaps are like put options embedded in mortgage bonds. You are paying a premium for this, and if defaults spike, your puts—your CDSs—go parabolic. And they have all of that kind of parabolic and levered instrument viability that’s built into them. It’s the same DNA as buying crash puts on an index. You’re going to bleed theta until the event happens, and then you get the convexity part of the trade coming into play. And when the housing bubble burst, those CDS positions explode and print life-changing returns for people like—you know—Michael… what was his name again? Michael…? 

Andrew Wilkinson 

I remember Steve Carell played him. 

Mat Cashman 

Steve Carell played him in The Big Short. But if you want to go listen or watch the movie, The Big Short is a fantastic retelling of this entire story. 

So, long puts—they feel like dead money, right? Until one day, you walk in and things are bananas, like I said. Things like that happen—not all the time—but occasionally. And this is how they did that in that situation. 

Andrew Wilkinson 

I think it took an awful long time, right? Because there’s an element in the film that describes the relationship with the ratings agencies, and the ratings agencies didn’t really care much about the actual quality of the bonds. So, you say theta bleeds on this—and it did, for even longer. Right. And I think the people who sold them the puts—the credit default swaps—kind of came back and demanded more premium, ’cause the market was really going against them. 

Mat Cashman 

Well, and what was happening is, as they were long those CDSs, which were embedded puts in that situation, they kept getting marked lower and lower because the rating agencies were saying to the greater public, “These things are AAA. They’re fine. Everything’s fine. There’s no reason to panic.” Meanwhile, the entire building is on fire out front, and no one wants to talk about it. But that is essentially the way that this option story played out—and the way that they made money on that front as well. 

Andrew Wilkinson 

Now, you mentioned earlier Mark Cuban and the deal being worth—or his worth being—$1.4 billion from that trade. Let’s go back to 1995: Nick Leeson and the Barings blow-up. And the sum of money involved in the breakage of the Barings Brothers Bank in London was $1.4 billion too. 

Mat Cashman 

Yes, and I want you guys to go back with us to 1995, because this is something that—before both of these trades went down—Barings Bank, a very conservative merchant bank in the UK, was actually really conservative and had been around for 200-plus years. I believe Barings Bank was the merchant bank that financed the Louisiana Purchase, if that gives you any idea of how long this bank had been around. 

Andrew Wilkinson 

Yeah, I wasn’t around for that one, no, Mat. 

Mat Cashman 

Neither was I—despite the fact that I actually talk about markets like I’ve been trading them for 200 years. I actually haven’t been trading them for 200 years, thank God. But let’s go back to ’95. Nick Leeson, who was the trader at Barings Bank, is supposed to be arbitraging Nikkei products in Asia for Barings Bank. He’s actually burying his losses—doubling down on short straddles, short premium trades, short at-the-money calls and puts that look like free rent in this situation—and collect every day, right, as the index sits still. 

Andrew Wilkinson 

All you need is… 

Mat Cashman 

All you need is nothing to happen. And particularly, what you really need is for the Kobe earthquake not to happen. However—guess what—you may understand that the Kobe earthquake did actually happen. The Nikkei tanks, short gamma explodes, Nick Leeson’s delta goes very wrong, very fast. As you might imagine, when you’re short a bunch of premium and something like that happens, your delta gets real long, real fast, on the way down—the wrong way. And so he constantly scrambles to buy more of the underlying, buying stock. His hole just continues to get deeper and deeper. 

Fast forward—to Barings, a 250-year-old institution. The oldest financial institution in England blows out—with one trader basically being short too many options. Now, part of the reason why is because he was actually hiding his options in the 5/8 account. Eight is considered a very lucky number in Asia. He called it the 5/8 account for that reason—it was actually five of the number eight as the account number. Very cheeky, as it were. But he would just say, “Put it in the 5/8 account,” right? And that’s where it would go. And no one would talk about it. 

But guess what—when things get really nasty, you have to talk about it. Because they lost north of a billion dollars, which happened to be more than the actual bank had on hand. And within 48 hours, the bank went under. 

Andrew Wilkinson 

Yeah, and it got sold to Barclays for a pound? 

Mat Cashman 

For one measly pound. One other interesting thing here is that one of the reasons why Nick Leeson was able to do this is he was both the head trader and the head of back-office settlement—both actual titles in one person. Guess what? That’s a bad idea. Let’s not do that ever again. But that was what enabled him to do things like this. 

So the takeaway here is that short options are not guaranteed rent checks. They can be grenades—because they have unlimited risk associated with them. Manage the size of your option trades. Know about the gap risk and respect the liquidity issues that might exist when you get into these trades. It’s a really important part—particularly if you’re going to trade from the short side. 

Andrew Wilkinson 

Doesn’t it make you wonder what would’ve happened had he been right? 

Mat Cashman 

Yes, it does make me wonder that. And my guess is that had he been right, he would’ve been made a partner at Barings Bank and paid out in stock instead of being paid in cash—and probably would’ve gone on to do exactly the same thing in some other industry after he reached escape velocity and left the finance world. 

Andrew Wilkinson 

Bigger—and only bigger and better. 

Mat Cashman 

Yeah, bigger. On a bigger scale, 10 years later. You know, or maybe he would’ve taken all of his money and blown out betting long tech stocks in 1999. But who knows? The real takeaway here is—the optionality that existed in these trades, they ended up being grenades, right? Because of their open-ended risk on both sides. 

Andrew Wilkinson 

Mat, let’s do a quick lightning round. Give us a couple more. 

Mat Cashman 

All right, I’ll give you three more. 1987—in portfolio insurance. That’s a really great story if you haven’t heard that one. Tie that up—institutions really tried to basically synthesize puts by selling futures into the drops that happened in the indexes. Now, that puts everyone basically short gamma at the same time. It’s a feedback loop, and what we ended up getting was Black Monday—where they tried to sell as many futures as they could at every tick down, in a systematic way. And it was kind of like someone forgot to turn the machine off, and it was just hitting bids and hitting bids. That was what caused the Black Monday 1987 drop. We also have the Hunt Brothers and the silver trade that they had—they were long futures, long calls, maximum leverage, way out over their skis. They were famous for trying to corner markets. They were actually quite good at it and had done it before. But in situations like this, I used to trade on the Chicago Board of Trade, and oftentimes overnight— The Board of Trade would raise margin requirements on futures. Sometimes it would happen as a way to control speculative activity. All of a sudden, if you’re long a bunch of futures, the Board of Trade just says, “Hey, guess what? The margin requirement on soybeans just went up overnight—and you have to put up 30% more money.” It’s a way to curtail people from doing this. But in certain situations like this, margins rise, liquidity vanishes, and guess what? They’re long futures, long calls, long everything—and they have to get out. So, options don’t save you from the physics of the situation in that situation. And they had to sell. 

So, the last one—one that people talk about an awful lot now—which is Volmageddon in 2018. These were inverse VIX ETNs. They’re a little bit harder to understand because it’s not just like, “I’m long the underlying in size and the thing crapped out,” but you’re really short vol—until one day you’re not really short vol anymore. And that’s really convexity hiding in plain sight. 

The takeaway from that oftentimes is: make sure if you’re trading an ETF or something along those lines that you understand what the optionality is that’s embedded into it. Because it’s not always crystal clear as far as those things are concerned. We have a lot of ETNs and ETFs that are listed now. My advice to everyone when they’re trading those things is—read the fine print. Make sure you understand what you’re trading before you hit the buy or sell button. 

Andrew Wilkinson 

Let’s just turn to the Greeks—in plain English. Give us the floor-trader cheat sheet on the Greeks, Mat. 

Mat Cashman 

Yeah, absolutely. There’s two real—I mean, the big ones. Delta is really direction. Delta is, “How exposed to the direction of the underlying market am I?” And so whenever people talk about their delta, that’s really what they’re talking about. 

Gamma is how fast your actual option position can change directions of delta. So gamma affects delta. It’s a second derivative that moves delta around when the underlying moves around. That’s something that’ll change your delta over the course of a move. 

Theta is basically like what we call—you know, we term it as rent, or, you know, paid or collected on a daily basis—but it’s not guaranteed. It’s a way that people forecast how much an option’s going to decay over a 24-hour period of time. But again, it’s not guaranteed, and theta doesn’t always show up. And then Vega is really what people think about as the market’s fear gauge. Vega is an option’s sensitivity to implied vol moves. Vega is also positively correlated to duration. So options that have more time in them until they expire generally have more vega in them—they’re more sensitive to implied vol moves, but they’re less sensitive to underlying moves. 

Then we have skew, which is the tail—kind of, which side of the distribution is priced higher. Put skew generally is priced higher in indexes and equities, but it’s not always that way. Sometimes, in the commodity markets, you can get call skew higher than put skew. And that’s really the cheat sheet on the Greeks. 

Andrew Wilkinson 

Excellent. Three brilliant stories, three clean lessons, Mat. 

Mat Cashman 

Well, I want to wrap it up by saying, you know—in calm markets, the theta part of this really rules. But in panics, gamma is going to be something that’s going to really take over and be the story that people are going to want to talk about. Make sure you respect both of them. The first one I want you to think about is the defined outcome story that we told—the Mark Cuban story. Define those outcomes—especially if you have something that’s like a really concentrated holding of an underlying somewhere, where all of your net worth happens to be locked up in one stock. Mark Cuban did it, and it really saved him and started his investment career. 

So, the other thing is—don’t forget about the side of the distribution that people might not be thinking about very much, right? When we’re talking about 2008, that was something that was kind of hiding in plain sight. It was right there. You know, I remember looking at the person wearing the t-shirt that said, “I’m short your house,” and not really understanding what that meant. And then going in and starting to do some digging and being like, “Oh, this is—there’s something going on here that’s really interesting.” Pay for that convexity when your thesis is on the other side of the consensus of everyone else, right? So oftentimes, it can be really cheap to get that exposure when no one thinks it’s going to be something that shows up on their bingo card for that year. And then, if you’re short gamma or short options, you have open-ended risk. Don’t forget about that—it’s open-ended for a reason. The reason you theoretically get paid that theta is because you’re giving that optionality to someone else. So keep an eye on that. Make sure that’s on your radar, because Nick Leeson and Barings Bank and all of the people associated with that learned that lesson the hard way. So, don’t forget about those three things. Hopefully, these stories were entertaining and can teach you something about options as well. 

Andrew Wilkinson 

Lovely. Thank you very much, Mat. This is a really good way to wrap that up. And if you enjoyed this one—for the audience—share it with a friend who’s sitting on a concentrated stock grant and saying, “I’ll probably be fine.” 

Mat Cashman 

Read the documents. Know the risks. Always enjoy. We’ll talk to you soon, Andrew. Thanks for having me. 

Andrew Wilkinson 

Thank you very much, Mat Cashman. And to the audience—if you did enjoy today’s episode, don’t forget to subscribe to the IBKR Podcast channel wherever you download your podcasts from. Bye for now.