Stock Market Wizards
Alphonse “Buddy’’ Fletcher Jr: Win-Win Investing
Alphonse Fletcher Jr gained interest in markets during high school when he worked on developing a program to find winners on the dog race track. During his graduation from Harvard University, he tried to evaluate what would happen if an option price was forced away from its theoretical value by placing large buy or sell orders that moved the market. His results convinced him that he had found a consistent way to capture profits in the options market. However, that idea of making money was the opposite of all the theories he had learnt about the markets.
His analysis implied that it was possible to implement offsetting trades, in which the total position had little or no risk and still provided a profit opportunity. In the real world, such discrepancies might occur because an oversized buy or sell order might knock out a particular option or security. However, in the theoretical model, it will be impossible to show a consistent risk-free opportunity if the efficient market hypothesis is correct.
His initial success came from a brilliant insight: Whether the markets are efficient or not, if different investors are treated differently, it hints at a profit opportunity.
He knew that arbitrage will only eliminate opportunities where both parties have the same costs of funds. If, however, one’s cost of funds is significantly higher or lower, then there will be a chance. In a more general sense, the markets might be priced very efficiently if everyone had identical costs of funds, received the same dividend, and had the same transaction costs.
He explained that the market was pricing options based on a theoretical model that assumed a risk-free rate. For many investors, however, the relevant interest rate was the cost of borrowing, which was higher. For example, the option-pricing model might assume an interest rate of 7% while the investor might have a borrowing cost of 8%. This discrepancy implied a profit opportunity. He used option box spread (a trade that involves implementing four simultaneous and separate option positions) to gain from this inconsistency.
Fletcher attributes his success to the lessons he learnt while working for Elliot Wolk- Never make a bet you can't afford to lose. He still follows the rule of risk aversion. He sticks to the rules of his first job of making significant returns from minimum risk and capital.
He believes some companies have much greater difficulty attracting investment funds than other companies with equivalent long-term fundamentals. By identifying these companies, Fletcher can structure a financing deal that offers these firms funds at a lower cost while at the same time providing him with a high chance of low-risk profit opportunity.
The reason for his success is risk control and innovation.
Although the details of Fletcher's approach are not directly applicable to ordinary investors, the two goals still represent worthy goals for all market participants.