Profiled in Jack Schwager's book The New Market Wizards, Blair Hull has been labelled by Forbes as one of the most successful traders of the last 40 years.
He first made his money during a five-year stint playing Blackjack in the 1970s before going on to trade mispriced options. This led him to form Hull Trading in 1985. Fourteen years later, the firm was acquired by Goldman Sachs for $531 million.
In this interview with host Aaron Fifield of Chat With Traders, Hull discusses his time in Blackjack, getting into trading, making money during the '87 crash, and being bought by Goldman. Read excerpts below, or listen to the interview in full here...
If you’re missing an edge, there’s no reason to play.Blair Hull
My brother in law used to go from San Francisco to Tahoe every six weeks or so and he’d play blackjack. He said he paid for his vacation by going and playing blackjack. I thought this is ridiculous, this guy is an accountant, if he was really making money he wouldn’t be playing at the $1 table, he’d be playing at the $5 or $25 table. And so I didn’t really believe him, but I did read the book Beat The Dealer and I did it myself to some extent. I found that there was an edge and you could get an advantage from playing blackjack. For the next five years from 1971 to 75 I played 50 days a year while I still had a full-time job. Every chance I had I was in Nevada, either Reno, Tahoe or Las Vegas.
The book Beat The Dealer by Ed Thorp, that really came out of an academic article in 1958 and it was a hardback book in 1962 and then a paperback in 1966. This gave a strategy - and there have been 1,000 books written on blackjack since that time - people realised it was a winning game and with all good things, they do go away, the casinos learnt how to counteract the players over a long period of time. It took them until this century for them to learn to counteract the players to such an extent that it’s very difficult to beat the game of blackjack today. But it’s still possible, the best edge you got was 51 – 49, a 2% edge, for every $100 you bet, you win $2.
It takes you a long time to get into the long run, you go up for a weekend and play eight hours a day two straight days you still only have a two out of three chance of being a winner over that weekend. So this was a game of chance and having the odds in your favour was certainly a game I wanted to play. I’m an investor, I’m certainly not going to play with somebody where the odds are in someone else’s favour. Anytime I make a wager, whether it’s on the golf course or wherever, I must have the edge in my favour.
I have a philosophy that all great things that happen in our world, happen with teams, not with individuals. I learnt that at an early age with the blackjack team. The first thing I did when I learnt about the blackjack team was I met the founder and then had to go and take some tests, some exams. One of the exams was you took a 52-card deck and took two cards out and took a stop watch and said ‘ready, go’, and he’d want you to count the cards and tell him what the last two cards were and be correct all the time. So I had to be relatively fast, and I developed a skill of how to count cards.
The second thing I had to do was take a basic strategy test, that is, what would you do if you know what the dealer has and what cards you have. It’s usually a multiple-choice question; hit, stand, split or double. I took that test and I think I got 94 out of 100 right. Well blackjack really requires you to get all of the answers right. You’re going to give an edge back to the casino. The fact that we took exams, there were ten different timed tests in order to qualify, made you a much better blackjack player than I was originally. It certainly did help to get more money into action (in joining a team), more individual bets allowed you to get into the long-run sooner.
On getting into trading...
The team got barred in 1976, so it was hard to get a game, but at the same time I had been working on developing a model that would calculate the expected value of an option. And I associated a probability distribution with a stock outcome and then I’d calculated the net present value of the expectation. That model actually converges into another model that was developed a year earlier called the Black-Scholes model. So, I had developed something very similar, at the same time it was developed. So, I had a value of the option and then I tried to buy cheap options and I tried to sell expensive options. That was the strategy.
In any kind of a game, whether its gambling or investing or whatever, there are two things you need, you need an advantage an then you need to stay in the game. What blackjack taught me was what I had that in proportion to my bankroll I had to bet in proportion to my advantage. If I had a big advantage I could bet more money but never more than 1/50 of my bankroll. So, if I had $100, I could never bet more than $2, otherwise you will risk ruin, losing all your money. So, when you’re playing a game, trading or blackjack and you lose half your money, you have to cut your bets in half. And most people would try to get even, but you have to do the opposite. I would say staying in the game was the most important thing that I learnt.
In fact, I actually started in the Pacific Stock Exchange where I leased a seat for $500 a month. But I would go around and there would be an option that would be where all the public would be going after this option, I had its worth according to my model, say 75c, when it was selling for $1. So I had sold maybe 200 of these options and I would run around and I would say ‘that’s such a juicy bet’ and then I’d look at the price again and say ‘I’ve got to sell some more of those’, then I’d say ‘I’ve already have that bet on the table’. I envisioned a stack of chips, so I wouldn’t over bet. Over betting is the thing that kills you in any kind of game, you could have a winning strategy but because of the way you wager, you can almost be guaranteed to go broke.
I took $25,000 that I had won on the blackjack tables, this is in 1974 dollars, so you would put almost a ten multiple on that I guess in today’s dollars. I was pretty successful, in those days options were mispriced and it was much easier to beat that game, much easier than it is today.
On the 87’ crash...
Well the 87’ crash, we had options on all kinds of places. By 1987, we had built an organisation and had 19 people working together. I am a believer in teams, but I did start as an individual, I hired somebody, we made a partnership. It was interesting that the banks and Federal Reserve tightened credit at the worst time, they suddenly told everybody that they had to reduce their positions. So that put me in a position, we happened to be short the major market index, which was a mirror of the Dow.
On the Tuesday when the market reached a low, I had to go over to the CBOT [Chicago Board of Trade] because I was the only person who could actually trade on that seat. So I was actually in that pit at that time and it was interesting that the NYSE, everybody had panicked, they didn’t know what to do, the Chicago Mercantile Exchange was going to halt trading. I was trying to figure out what happens on trading halts. We wanted to be long on the halt and then I was in the right place at the right time, when a firm that used to exist, Drexel Burnham, came to the floor and the only place they were trading equities was CBOT. And this major market index, they asked me whether I would buy 100, they knew that I was the guy that was on both sides of the market and I gave them a ridiculously low price and they said sold. They sold me another 50 contracts. So I was in the right place at the right time.
On Hull Trading...
It was an extenuation of my own trading. Normally on a floor of an exchange, a trader would have clerks and I had tried to build a computer system, I knew that things ought to be automated when I saw the exchanges when I first walked down. I had been a computer programmer before, having some programming experience. I knew when I saw the floor in 1976, I said ‘this place, my god, if I come down here, I better make a lot of money very quick because it’s all going to be automated’. I knew the direction of technology, but my timing was off by about 30 years. It took us until the year 2000 to get automated options exchanges.
I had had a job in corporate America, so I looked at things from an organisational stand point. We did believe that one needed a productive way of buying and selling things, especially in the options market as everything was related. So we had quantitative models that would tell us how to price the SPX options vs the NASDAQ options. And so we needed mathematicians and computer scientists who not only come up with the algorithms that would give us fair values to risk adjust those fair values, and then automate that process to get those prices to the traders. That took a lot of higher mathematics and computer skills to do that.
Most of [our strategies] were trying to buy undervalued securities and sell over-valued securities and stay as neutral as possible. Nobody liked risk, but our capital would swing significant amounts on any one day just because things became more or less miss-priced. Although we did do a lot of option strategies and of course we hedged the underlying instrument, if we sold calls on IBM, chances were we were a buyer of the stock. But another strategy we deployed in 1995, we bought and sold securities in a separate portfolio. We automated a process and we would do things like, you might think of it as pairs trading, where you would buy one stock of Pepsi and sell Coke, it used to be General Motors and Ford, or it might be Morgan Stanley and Goldman Sachs. What we did is we took a security and took the five most correlated securities and we built a basket and we said that this stock would follow that basket. So if that industry tended to go higher, we would tend to be a buyer of that stock etc. So we tried to fairly price securities and we would make a market around its fair value. Everything we did was to come up with a fair value and put a bid and an offer around that fair value.
On Goldman Sachs...
I think they saw the way the world was going, they couldn’t compete without an automated electronic market maker. A market maker that could analysis data and come up with fair values of securities so they could trade them, provide good liquidity to their customers and others. They saw that they could build what we had but it would have probably taken them two years to get to where we were and by that time, we would be 18 months ahead of them. So they just wanted to shorten up the process.
The first thing they did (once acquired) which was really quite bright, they then went on a hiring spree. There were 250 people in the firm when we sold, within a year, they had 450 people. So what they did is, and actually Henry Paulson said this, "I look at this as a DNA transfer, what we’re going to do is take your methodology and the way you look at problems and markets and we’re going to take that throughout our firm." So I thought they were very effective in the way they hired and trained people.