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Using currency options to make
$2 billion in 10 weeks --
or how George Soros broke the
Bank of England
In the early 1990s, former British Prime Minister Margaret
Thatcher decided the British pound should be part of the European
Monetary Mechanism (ERM) -- which was essentially a scheme to
anchor European currencies to the German Deutsche mark.
In Thatcher’s eyes, a strong pound was a measure of
Britain’s important standing in the world. It was also a
vindication of the economic policies she was trying to push
through parliament.
So, for political reasons, she chose to fix the value of the
pound at a very high level. Unsustainably high, in fact. As the
weeks went by, downward pressure on the British currency in world
markets slowly intensified.
But Thatcher was accustomed to prevailing over determined
opposition. She wasn’t called the “Iron Lady” for nothing. She
dug in her heels and ordered the Bank of England to defend the
currency ... right down to its last shilling -- which it dutifully
did.
The effort was futile. Approximately US$3 trillion surge
through the world’s foreign exchange markets on any normal
business day. That’s an ocean of money big enough to swamp the
Bank of England, the Bank of Japan, and the US Federal Reserve all
rolled into one.
The international
currency markets comprise the
biggest, strongest, free
market in human history. Any
time a government does
something economically stupid,
sooner or later its currency
pays the price.
Legendary speculator
George Soros was among the
first to recognize that the
pound’s artificially high
exchange rate could only be
sustained as long as the Bank
of England kept buying up
massive amounts of sterling on
world markets.
Obviously, this couldn’t go on forever. Eventually, even
the Bank of England would run out of money, and intervention would
have to stop.
So Soros began accumulating a massive short position in
sterling. Seeking maximum leverage, he made full use of sterling
put options.
Sure enough, in mid-September 1992, with its foreign
exchange reserves running perilously low, the Bank of England was
finally forced to throw in the towel.
Unsupported, the pound fell 24% over the next 3 months.
Sterling put options that Soros bought for US$2,000 before
the devaluation, were worth US$273,000 just a few weeks later.
That’s a 13,550% gain.
Although Soros also used other leveraged securities (such as
futures and forward contracts), currency options were a key part
of his position.
That’s how he made US$2 billion in a matter of weeks. And
it’s how he made his famous reputation as “the man who broke the
Bank of England.”
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