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Chapter 14. Betting the Bank > Kent Ahrens and First Capital

Kent Ahrens and First Capital

One of the first and most common types of arbitrage on Wall Street was the S&P 500 Index arbitrage. This arbitrage is similar to the arbitrage conducted by Nick Leeson for Barings Bank using futures contracts on the Singapore and Osaka exchanges. While Leeson was looking for mispricing between contracts traded in two locations, both based on the Nikkei 225, the first S&P 500 Index arbitragers looked for mispricing between the S&P 500 Index futures contract and a basket of stocks that represented the actual S&P 500 Index. If the futures price seems too high compared with the actual index, the arbitrager sells futures and buys stocks. If the future is under priced, then the trader buys futures and shorts stocks. Often times, computer programs analyze these prices and identify mispricings. The process is often referred to as program trading. This arbitrage is generally considered low risk and earns a low return.

In 1992, Kent Ahrens was conducting index arbitrage for First Capital Strategies, who invested money for the Common Fund. The Common Fund manages investments for over 1,400 educational institutions, mostly universities. One day, Ahrens was only able to take one of the two positions needed for arbitrage before the markets closed. That is, he shorted the stocks but failed to buy the corresponding index future. This left him in an unhedged position overnight. The open of the next day was higher, so Ahrens found that he had incurred a small loss, around $20,000. Instead of reporting his loss, he tried to make it up through trading.[9]


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