TRADING SILVER INTO BILLIONS

 

One day, as Peterffy delivered another batch of reports, Aranyi mentioned an unusual client: "I know a crazy psychiatrist who wants to do some computer work. You should meet him."

The psychiatrist was Dr. Henry Jarecki, a former Yale professor who had left medicine to establish the American operation of Mocatta & Goldsmid, one of the world's leading bullion trading firms.

While examining a dollar bill from his wallet, [Jarecki] noticed the words "Silver Certificate." He called the Treasury to ask what that meant, then walked into their office with a single bill and demanded his ounce of silver. The clerks needed a day to locate the metal, but they honored the exchange.

Silver was trading at $1.33 per ounce. The government was selling it for $1.00.

Jarecki hired teams to collect Silver Certificates still circulating in grocery stores and banks, offering five cents above face value for each bill. But the operation created risk. He was accumulating piles of silver whose value might fall before he could refine and sell it. He needed futures contracts to hedge the position, and he needed someone who understood both programming and markets to manage the complexity.

In 1969, after negotiations with Aranyi, Jarecki hired Peterffy permanently on a salary of $20,000. His first assignment was simple: trade silver and try to make money.

"I had a horrible time," Peterffy said. "How do you decide when you're going to buy or sell?"

He had no framework for decisions, no system beyond intuition he says he didn't possess. But Jarecki had a larger vision. He wanted his nascent business to become a bullion dealer, quoting continuous silver and gold prices to banks and traders in New York, London, and Hong Kong—the exact problems computers solved best.

Peterffy designed the system from scratch. Teletype machines hammered out shipping, market, and economic data on continuous paper strips. Clerks tore off the feeds and punched the numbers into IBM computers, where Peterffy's programs ran the data through proprietary equations and printed fresh bid-ask quotes on green-bar paper. Runners grabbed the sheets and raced them to the trading pit, where clerks gave live prices through hand signals. Other firms relied on their traders' intuition. Peterffy built a machine that ran on math.

The system's value became clear on August 15, 1971, when President Nixon dismantled the Bretton Woods system by ending gold convertibility and letting the dollar float. Currency markets collapsed into chaos, and for almost a week, Mocatta was virtually the only firm in the world making markets in silver and gold.

"As soon as the electronic brain is hooked up to its voice box so it can answer the phone," Peterffy told Barron's magazine that September, "staff will be able to go on permanent vacation."

When I read him this quote, he didn't remember saying it. But the words reveal how clearly he saw the future.

When Peterffy proposed expanding into stock options, Jarecki refused, preferring to remain a precious metals dealer. Jarecki had watched another options firm collapse—fraudsters who promised profits to both buyers and sellers on identical trades. But Peterffy possessed something the swindlers had lacked: In the early 1970s, years before Fischer Black and Myron Scholes published their Nobel Prize-winning paper, he had used his own Olivetti P101 to invent a partial differential equation that priced options based on variables such as the underlying asset's price, volatility, and the option's time to expiration. Mocatta had been testing the formula quietly on silver options, making money on almost every trade.

The success made Jarecki's refusal more frustrating. Over seven years, Peterffy had watched his boss become known as the dean of the American gold market. When I asked what Jarecki had taught him, Peterffy didn't hesitate.

"He was a very well-educated man, but he was a psychiatrist. He didn't know anything about markets. I realized: If he can figure it out, so can I."

In 1977, with $200,000 in savings, Peterffy left Mocatta and bought a seat on the American Stock Exchange for $36,000.

To read the complete article, see:
The Making of a Market Maker (https://joincolossus.com/article/thomas-peterffy-market-maker/)

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