Leverage is a double edged sword

How Leverage destroyed $10billion in 5 Days

There’s this man named Bill Hwang. He is a Tiger cub, having worked for the hedge fund named Tiger, run by Julian Robertson. Hwang runs New York based Archegos Capital.

Archegos was a family office of Hwang, and ran prop capital of around $10 billion, it seems. But the real exposure was much more. What Hwang did, it seems, was that he didn’t buy stocks directly – he bought a certain “derivative” instrument called a Contract for Difference (CFD).

In a CFD, you deal with a bank and say, “listen, if the stock goes up, you pay me the difference, and if it goes down, I’ll pay the difference”. The bank then takes the underlying position in your name, and hedges out the risk. The stock is held by the bank, not in your name.

Effectively, Hwang could build large positions in certain stocks without revealing that he owned those position. If he had bought stock directly, anything above 5% had to be reported. But it wasn’t because of the CFD trick.

But that wasn’t the only trick. Hwang had $10 billion. His positions were $50 billion.

How do you get 5x Leverage?

The 5x multiple was “leverage”, offered by large banks such as Nomura, Credit Suisse, Morgan Stanley and Goldman. He’d put his $1 and they’d lend him $4 against the security of the very stocks he would buy through a CFD. All it took was for Hwang to ensure that he paid up if the stocks fell down.

And the stocks kept going up rapidly in 2021, with once of them – ViacomCBS – moving from $36 to $100 between the start of 2021 to March 22.

The Fall: Just three days took it all down

As the stock went up, it appears that Hwang kept using the money earned to buy more of these stocks, such as Viacom and Discovery. He also owned shares of Baidu, Tencent and a bunch of Chinese tech companies.

Take Viacom. between March 23 and 24, the stock fell from $100 to $67. A 33% fall in three days . Now think of this:

  • You have $100 multiplied to $500 by leverage offered by the banks.
  • You own $500 worth of Viacom, but not in your own name – as a CFD. So the shares are owned by the banks and kept as collateral.
  • The stock falls 33%.
  • Effectively you’ve lost $150.
  • You owned only $100 in the first place
  • The bank says hello, gimme the extra 50 and then some more to cover for volatility.
  • You don’t have it.
  • The bank panics and starts selling the stock like crazy.

Just on Friday (26th), the banks dumped shares of the companies that Archegos had exposure to. More than $20 billion.

Archegos was essentially a CFD bet on steroids.