Coffee (4 page)

“Oh?”

“It’s
not uncommon in the investment houses. I helped Dartmouth design
it. But I thought you were the one with the story to tell.”

“How’s
it work? How much money can you play with?”

Warren
huffed, “A chunk of the portfolio is left aside for the
manager to have full say - to take some calculated risks. If you
beat some target rate of return, the manager gets to keep some of
it. In the big firms, if you play your cards right, you can make
millions, some even billions.”

Knut
jumped in. “But Dartmouth had better cafeteria food, right?”

“Right.
Chile con carne from a can, same reason you don’t walk out
and get a six figure salary someplace, Knut. You know damn well it
would take you about ten minutes to find one.”

“Actually,
for me it’s the baked beans and ketchup.”

Etty
recovered the topic. “Boys, this is my show. Continue,
Warren.”

“So
I have a speculation fund, some dollars I can do what I want with,
with only a few exceptions. Then, as my incentive I get a quarter of
any earnings over 10%. It’s not great, but it can add up.”

“What
if you go under?”

“If
the return is 10% or under, I get nothing. Of course, if the return
goes negative, I get fired and probably never work again.”

“How
much money is in the fund?”

Warren
rolled his eyes at Knut, even though he couldn’t have seen.
“Harriet, where are you going with this? The speculation fund
is fifty million.”

Knut
jerked and had to scramble to catch the papers in his lap from
falling. “Fifty million dollars? This is your little ‘spec
fund’?” Etty reached over and took the papers from
Knut. She scanned them quickly, pulled one report to the top, and
turned back to the discussion.

“Yea.
It’s not that much, really. Remember the total portfolio is
800 million,” Warren said with sincere surprise at Knut’s
reaction. “I had many times that in New York.”

“What’s
the money in now?” Etty continued.

“Listen,
I have a lot to do. If you have a proposal, I’ll hear it.
Otherwise ... ”

“All
right, all right. Sorry if I’ve been rude, but we’re in
a tight time frame. I’m looking for someone who wants to make
a sizable investment, and if you didn’t have the capability, I
didn’t want to waste your time.” She straightened in
the chair. “Let me explain.”

Etty
described in detail the price abnormalities in the coffee market.
Knut helped by reciting his analysis. Warren watched with growing
interest. In his fifteen year career, he had never seen such
dramatic proof of market manipulation before it was discovered by
the authorities. He had read of the Hunt Brothers cornering the
silver market and a few others, but this was still fresh.

“Hell
of a thesis. The chances are good there’s someone behind it.
You’ve got it made - just write the paper, sit back, and watch
the University Presses fight to print it.”

“But
Warren, this is happening
tomorrow
! If we’re right,
there’ll be another one of these price spikes in less than
thirty hours. Do you know what you could do with this knowledge?”

While
Warren wondered how to answer, Knut interjected, “Why on the
first Tuesday of the month?”

“That’s
easy,” Warren said, happy to change the subject. “The
agriculture report comes out of the World Food Federation on the
first Wednesday. Their numbers can make markets crazy. They track
things like world crop conditions. If a weather or disease problem
is discovered which might lower supply, prices jump up.”

“So
why the Tuesday before?” Knut persisted.

“This
Global Growers guy wants to force up the price of Coffee for some
reason. He has a lot of money and coffee to work with, but still,
it’s only a fraction of the total coffee market. He wants a
lot of bang for the buck, so he works in a skittish market. What
better time than just before the ‘Ag’ report comes out -
when anxiety is high.”

“Makes
sense to me.” Etty nodded.

Warren
elaborated. “Since the numbers on Wednesday are so important,
everyone gets their underwear in a bunch on Tuesday, scared to death
that someone might get an early peek at the report. If some big
buyer comes into the market and starts buying like mad, bidding up
the price, the rest of the guys out there start thinking the buyer
knows something they don’t. They get nervous. Some can’t
stand it and start buying themselves. The price goes up and up.”

“Global
Grower’s been at this a while, you’d think the market
would learn,” Etty realized.

“Good
point. Probably won’t work too many more times. Others will
figure it out eventually. But you’d be surprised how many
things defy logic in our supposedly ‘efficient market’.
For one, the buyers and sellers change all the time in the pit where
they trade. It’s a burn out job - most don’t last a few
months. Each time Global pulls this, there may be a whole new group
of unsuspecting traders.”

Knut burst in. “Come on, Etty, let’s get to the juicy
part.”

She
paused while she planned her words, agreeing it was time for
specifics. “Warren.”

“Yes
Harriet?” he mocked. “If you think I am going to buy
coffee for the Dartmouth Endowment Fund, you’re demented.”

“What
if you just wanted to get the benefit of the price increase without
buying the actual investment?”

“I’m
supposed to say, ‘I’d buy Coffee Options,’ right?”

Knut
loved this game. “Bingo!” he yelled. “Now, Etty,
explain the Option dynamics. How does Global get paid with them.
I’m all ears.”

After
smiling at the irony in Knut’s comment, Warren sat back, a
little impatient, and started bending paper clips into little loops.
He also knew options extremely well from years of using them as a
component in his stock funds. But, he decided to let Etty explain
to Knut, interested on how she might present a topic that many
people have difficulty ever understanding.

Etty
turned to Knut. “Let’s say coffee sells for $100 per
unit...”

Warren
interrupted, “Coffee sells in 2,000 pound lots.”

Etty
flicked a vexing expression at Warren, then continued. “Let’s
say a hundred pounds of coffee is selling for a hundred dollars.
You look at price history, and you see that the price is almost
always between $98 and $102, with rarely any big jumps.”

Knut
listened intently. “I’m with you.”

“How
much would you pay for the right to buy coffee at $110, some time
over the next 3 months? An ‘option’ to buy coffee at
$110?”

Knut
thought for a second. “Not much. If the price never goes
over 102, then the option to buy it at 110 would be silly, and
therefore worthless, right?”

“Well,
not worthless, because in markets you never know. There is always a
little chance that prices will go crazy, but in my example you’re
close. You wouldn’t pay much, like maybe a buck.”

“Sure.
I’ll play. I pay a buck, and that gives me the option over
the next 3 months to buy coffee at 110 even though now coffee sells
at 100. If it happens to go to 120, I use my option to buy it at
110, and immediately sell it, and make 10 bucks.”

“Now,
all of a sudden, the price of coffee jumps to $103 in one hour,
courtesy of our friends at Global Growers. What do you think would
happen to the value of your option?”

“I
think you’re going to tell me.”

“It
would go up. If coffee can go to 103 in 1 hour, then it might more
easily get to 110 in 3 months, right?”

Knut
started seeing the finale. “Yea, I see.”

“Even
though the price of coffee is still way below 110 at 103, the
chance
that coffee could hit 110 goes up. Therefore, the value of the
option to buy at 110 goes up too. Make sense?”

Knut
let it sink in for a minute. “Yes it does.”

“It
might go to, say two bucks, which means the value doubled, right?”

“But
if you held onto it through the end of the 3 months, it would still
be worthless, because the price never went over 110.”

“Right,
that’s why you have to immediately sell it when the price is
up.”

Etty
sat back to enjoy Knut’s thoughtful expression, then added,
“Think what this means for tomorrow’s Coffee Options.
If you buy a million dollars of them at 9am, you could conceivably
have two million by lunch.”

Warren
cut in. “Thanks for the lesson, Etty. What about some facts.
Let me guess, you have option price history on that report in your
lap.”

“Correct.
These reports verify it. Coffee options behaved just like my
example right after the Tuesday price spikes.“ Looking down
at the printout, “Here’s one last year that went from
$1.20 to $2.42, here’s one that went from $0.90 to $1.75.
Both doubled or nearly doubled.”

Now
Etty returned to face Warren. “Listen to me guys. I have
stumbled on to a market manipulation scheme of monumental scale.
Thanks to your interesting addition about the agriculture report,
here’s how I think it works.”

She
guided her thick black hair away from her face with both hands.
“Clorice Coffee Company and Global Growers must have worked
this out as partners. Clorice’s seller goes to the trading
pit with lots of coffee to sell, the day before the ag report. The
Global guy suddenly starts buying, pushing the price higher and
higher over a short burst. Others join in, there’s a feeding
frenzy. Everyone thinks Global knows something from the report,
like maybe that world coffee supplies are about to crater. Clorice
makes out like a bandit, selling his goods at well above the market
price. He’s happy. Meanwhile, Global owns a huge pile of
options on coffee. The value of the options jump. They sell at a
huge percentage profit, like doubling their investment. Net of the
loss they took on buying the actual coffee beans at above market
rates, they still make out big time. They’re happy. The
price starts to drop again, and eventually returns to where it
started. Win - Win.”

Warren
reached toward Etty. “Let me see the printouts.”

Etty
stood and leaned over his desk to show the option price jumps on the
same days as the price spikes, then sat back, feeling victorious,
while he studied them.

Before
Warren spoke again, she continued. “Warren. Even if these
guys are scum of the earth, deserving to die a slow death, there is
nothing illegal about making an investment based on a hunch about a
change in value. People do it every day, every minute. You, more
than any of us, must know that.”

Knut
again interrupted, still back on the scheme. “You know, the
more I think about it, this is an incredibly smart game. The guy
who is creating the ruse, Global, does so by pushing up the price, a
deal where he loses money on the trading floor. He pays too much!
I bet the Securities and Exchange Commission looks for people who
make
money, not for people who lose. Unless they look
further into the Options market, they might over look the bad guys.
Clorice is safe too - who’d blame a seller for selling at the
highest price? Pretty good plan - pure genius.”

Etty
persisted. “Warren. You could potentially double every
dollar you invest in these things - in one day. The down side is
minor - if nothing happens, you’d only lose the commission on
buying the options - nothing for a big spender like you. You’ve
got little to lose, and with your incentive plan, you could keep a
piece of the gains yourself.”

Warren
had been way ahead of Etty on the commission math. His spec fund,
ironically, was heavily invested in
Reais
, the currency of
Brazil. Warren had been watching a steady increase in the strength
of the Brazilian economy. As Brazil improved, so did the value of
their currency relative to the U.S. dollar. He was already up 6%
from 3 months ago. But this! Currency was easy to sell. He could
convert any amount of it in minutes to whatever investment he
wanted.

Although
he kept it to himself, his main reservation concerned legality.
Could you get in trouble for profiting in someone else’s
market manipulation scheme? He would call the regulatory agencies
before considering it further.

“What
do you hope to gain from this, Etty, if I did make an investment?”
he finally asked.

“Gain?
One big party, that’s what! But otherwise, material for the
best PhD dissertation ever written. ‘How I earned millions
in one day getting my degree’. Can you imagine the look on
the faces of the Trustees when they read it? Besides that though,
nothing, Warren. I certainly wouldn’t expect to share in any
of the profits.”

Knut summarized, now convinced. “So what are you waiting for?
Sounds crazy to pass up.”

“I’ll
have to think about it.” He arranged some papers on his desk,
avoiding their glances. “This isn’t something you just
do. I’m not even sure how big the market for Coffee Options
is - if you invest too big a percent, you’ll change the price
with your own buying.”

“But
you’re interested. I know that tone of voice,” Knut
said.

Etty
studied Warren’s face. She sensed uneasiness, an emotion he
appeared unaccustomed to. The big New York high flying investment
guru steps way down to run a relatively small portfolio in a quiet
New England town, and suddenly gets stumped by a student - a pure
academic. Behind the macho build and newly pressed fashionable
clothes, she saw a window into the person beneath. Normally able to
command any meeting with the ease of a billionaire, here he sat, not
sure how to end their simple encounter. But his eyes glimmered.
Even with such a short interview, she perceived a kind, gentle man,
someone to trust. A wave of excitement prickled through her. This
was her idea, her discovery. Her blood felt hot.