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One of the more colorful expressions I've heard on a trading floor is the O'Hare hedge. It consists of a very, very large position, well over your authorized limit, and a one-way plane ticket to an undisclosed location. Preferably, this location is in a country that has no extradition treaty with the country you are a citizen of. If you win, you are rich. If you lose, the plane ticket will get you out. This is also known as an O' Hare straddle or an O'Hare spread. The name comes from O'Hare Airport in Chicago; many of the US derivatives trading firms are not in New York but in Chicago, and it normally takes derivatives to get the proper risk profile for this trade.

While this is a very funny (or not, de gustibus non est disputandum) joke, it underlines two issues with modern finance. The first one is more technical. Some derivatives have a very nasty tail risk. As an example, consider the Eurostoxx 50 index, which is approaching 3000 as I write this. Assume I sell the September 2010 2000 put. That's a put option that expires on September 2010, and forces me to buy the Eurostoxx 50 index at 2000 if the buyer of the put wishes this. This nets me a few euros per option. Assume I do this for size, so about 100.000 of them. That's a nice profit. Now, there are two realistic possibilities. If the Eurostoxx is above 2000 - very likely - I pocket a few hundred thousand. If not, well, it might be at 1900. Or 1500. In any case, I've likely lost many, many millions. The problem is that there is almost no way to hedge this. A cheaper, even further out the money option, such as the 1900, is almost as expensive, wiping out my profit and I could still lose 10 million euros. My only "hedge" is the O'Hare hedge.

Secondly, this is an example of a case in which the interests of a trading firm and its employee do not necessarily align. Imagine a trader plays it nice, and makes his targets. He gets a bonus that is normal for his trading firm. However, imagine he takes on massive risks. The best is a position that makes a lot of money normally, but has the possibility to lose colossally. He will likely make a nice amount of money and have a good bonus. If his position loses, he will lose his job. If he didn't commit fraud and didn't break company rules, that's it. If he didn't, like Jerome Kerviel, he also needs to invest a few thousand in the O'Hare hedge. Most trading firms are well aware of this, and structure risk management and their bonus structure in a way to discourage this.

As such, the O'Hare hedge is an example of a case in which profit is personal, but losses are for a collective. And yes, one could consider the 2008 crisis as a massive, global form of this trick. In fact, if you start looking for this principle, you can find it at many points. As another example, making bets that your house will rise in value and financing it with a massive mortgage could be example, if you did it on purpose: if you win, you win out big, if you lose, the bank gets to eat the loss. (I do realize that many if not most people in this situation were duped into it, and would not have played this game if they realized the risks.)

In conclusion, the O'Hare hedge is an example of a situation in which a party takes on so much risk that if things go wrong, he or she cannot or does not want to pay the damage. Using bankruptcy protection or a plane ticket, the gains are private, but the loss is for the collective.

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