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Introduction
Harry Markopolos wrote a book about his
uncovering the $65 billion Madoff Ponzi
scheme; and, his sharing with the SEC
detailed findings in 1999, 2000, 2001,
2005, and 2007. But, the SEC never
caught Madoff.
This presentation is an analytical review of
Markopolos findings.
Losses to Investors
In a Ponzi scheme, the earlier investors get repaid by the
later ones. So, it is not like the entire $65 billion was lost.
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The Put strike price is at the red line inflection point. If stock
prices along the horizontal line decline (moving to the left) of
the strike price, the Put is in the money and will cover
additional losses. Buying a Put establishes a floor on losses.
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The Call strike price is at the green line inflection point. If stock prices along the
horizontal line increase (moving to the right) of the strike price, the Call is in the
money. This creates a cap on returns because you are forced to sell the stock
at the strike price. This is to earn a premium on the Call to finance the Put
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premium.
Now the return profile looks very different than simply being
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long the stocks.
Problem: Skewness
Skewness implication:
Premium paid = Premium earned
Losses retained > Gains retained
For the same premium level, you
have to retain greater losses on
the Put (red box top graph) than
the gains you can retain on the
Call (green box below).
Skewness is really bad for a split
strike conversion strategy.
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For about $6 you could sell a Call with a strike price of 510 on the S&P 100. This is
16.1 points away from the S&P 100 current level at the time of 493.9. You could use
this $6 to buy a Put with a strike price of 455 or 38.9 points away from the current S&P
100 level. The distance of the Put strike price is more than 2 x the one of the Call 15
strike price (38.9/16.1). Thats bad.
Skewness = Asymmetry
At all option premium prices, the respective Puts strike prices are much
further away than the Calls strike prices. We highlight the difference in
strike price distance for a Call and a Put with a premium close to $6 as
shown on the previous slide.
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To avoid almost all monthly losses, Madoffs Put strike price should
have been very close to the current price. This takes him almost
out of equity returns and leaves him barely with a Risk Free Rate
(even less if you factor skewness and basis risk).
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Thats Consistency!?
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$8 billion investors
redemption requests
Lehman files chapter 11 on September 15, 2008. Within
next couple of months, the S&P 500 loses 30% of its value.
Investors flee to Treasuries. Their resulting yield drop by
175 bp. Investors request $8 billion in redemptions from
Madoff. He is arrested on December 11, 2008.
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