Hedging Stress

Cigars Ease the Tension for the Big Dogs on Chicago's Futures Exchanges

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"For every winner there's a loser. All these clichés work. But down there they're not clichés," Zawaski says about the trading pits, adding that fear is a constant on each of Chicago's three exchanges. "I saw one guy about a year ago, froze on some order. Lost about a million dollars. A million bucks, just like that." He snaps his fingers. "He froze. He froze for an hour. Once he missed [the trade] he realized, 'I'm in shit. I'm in trouble.'"

Because of his long experience, Zawaski, whose daily trading exposure is generally between $20,000 and $30,000, now makes money about eight days out of 10.

"As you get better, the more money you make, the less risk you want to take. So you're working less hours," Zawaski says, adding that there is tremendous competition among the traders. "The stress of standing there is just absolutely incredible. I mean, it just pours on you, it just beats down on you, and I can't take it. Massive, huge split-second decisions." That's why Zawaski tries not to spend too many hours in the pit.

The Chicago Board of Trade, the world's oldest and largest futures and options exchange, defines itself as the global leader of the "risk management industry." When the CBOT was established in 1848, trading was limited to agricultural commodities. In 1975, the CBOT inaugurated financial contracts and, in 1982, options on futures contracts. Chicago is host not only to the CBOT, but also the Chicago Board of Options Exchange (CBOE) and the Chicago Mercantile Exchange. The trading dynamics are fundamentally the same at all the exchanges, the major difference being the commodities or financial instruments they trade. The common function of the three exchanges is to provide a hedge for risk. Hedging is essentially the transfer of risk. Hedgers are the ones sloughing off their price risk to speculators willing to absorb and manage the risk. The traders speculate, using futures contracts and options, that the price of commodities or financial instruments will move.

Suppose a soybean distributor suspects the price of soybeans is going to rise precipitously in the near future. To protect himself he can buy a futures contract on soybeans that will be delivered in six months. The price he agrees to today will be the price he pays in six months, regardless of fluctuations in the value of that commodity. By locking in a price in advance, he effectively protects himself against crop failures or other calamities that would drive the price up and affect his profit margin. At the same time, the farmer who sells him that futures contract is agreeing to supply beans at that price. This allows him to plant the beans, secure in the knowledge that he will have a buyer at a certain price, even if the price falls in the interim.

The market risk has not been eliminated but rather assumed by futures brokers, who take a speculative stance, betting either that the price of soybeans will go up or down in six months. If they bet right, they can make a lot of money.

"Think of the futures contract as a pledge to deliver goods in the future at a pre-arranged price," explains former trader Ted Fishman, now a financial writer. The futures contract is not to be confused with an option, a different financial instrument though a variation of a futures contract. "An option is a right, not a promise. If you buy a 'call option,' you're buying the right to purchase something for a certain price. Only futures contracts obligate you to do anything. Options, like their name says, give you the option to buy something at a set price. The advantage of call options is that if the price goes down in the future, you don't have to use the option, you can just buy the stock at the cheaper market price and all you've lost is the premium."

In the trading pit, the proximity to others trading in the same product means that price discovery is at its most efficient. You know instantly who is willing to sell or buy and for how much. In many cases, the more the price moves, the more money there is to be made. With enough trades at small spreads (the difference between the bid and offer prices) a trader can make--or lose--a significant amount of money on any given day. Prices for agricultural products can be affected by any number of unpredictable factors--weather, disease, bugs--which in turn affect the price of the commodity. In the Treasury bond pit, the unpredictable factors affecting prices are, among other things, the perceptions of investors, the predictions of economists, financial analysts, the health of the economy, inflation, wars, politics and the policies of the Federal Reserve. All of these factors affect the price of money: interest rates.

"We're a hedge center between the Fed and the banks," says Zawaski. "They have to buy and sell and they need a place for liquidity to offset each one of these trades. That's what the bond pit is. Everything's totally connected, but we're kinda the big dogs. We're the interest rates. We're driven by interest rates. There's no bigger [market] in the world. The stock market even watches us. We're the big dogs."

The trader provides a risk-transfer service that most people don't recognize, appreciate or understand, says Paul R.T. Johnson Jr., a CBOT director and T-bond broker (a broker trades for clients while a "local," or "scalper," generally trades for himself). "It allows your and my home mortgage to be at a lower rate," Johnson says while smoking a Davidoff Double R after lunch at The Excelsior, across the street from the CBOT and down the hall from Jack Schwartz Importers where Johnson serves as vice president of the Jack Schwartz Cigar Club.

"The government has postponed [Treasury bond] auctions when we're not in," earnestly adds Johnson, whose "LSU" badge stands for his alma mater, Louisiana State University.

Johnson distinguishes between the exchanges and what he and many traders refer to as the "real" world. "I'm part of that which allows people to do real things out there," Johnson says, clearly focusing on important matters. "Like making cigars, so we can all enjoy our life; I really think it's a great part of life because you've really got to enjoy the pleasures. If you don't stop and smell the roses or sit back and relax and think about your fellow man, you're missing it all."

At 10:58 on that winter Wednesday, Zawaski is just climbing into the pit, a few feet and a mass of humanity from Baldwin. Three minutes later he is executing a trade. At 11:05, the pit erupts. The price is up slightly. At 11:08, there is a two-point drop. Then it's down another point just 11 seconds later, according to the numerous clocks and quote boards encircling the trading floor. The hits just keep on coming.

At 12:15, Avi Goldfeder, Johnson's partner, is ready for his midday meal. He reaches into his briefcase and pulls out a bottle of aspirin. "Well, here's my lunch," he says, taking out two pills and popping them into his mouth. No smoking on the trading floor.

Steve Horowich is standing on the top tier of the pit, looking out. He is trading for the brokers who have "decks," which are little more than consoles with as many phone lines as possible, which reach out to different clients around the world. Brokers are paid a commission for the trades they execute, and Horowich and his group make about a dollar per contract traded that they handle for brokers like Johnson and Goldfeder. On an active day thousands of trades are being made. To save time in communicating information in a pursuit where split-seconds count, Horowich stands back-to-back with one of his associates and leans backward to talk to him. The associate, at 6 foot 10 inches, is the tallest trader in the pit, which is a significant advantage.

"It's stressful," Baldwin says of trading. "The actual trading part is not as stressful as the physical part of it because the trading conditions are so miserable, standing there packed in the pit. That's so uncomfortable, that's the worst part." Baldwin is 5-foot-10-inches tall and slender, but the pit is full of much bigger people, some of whom are former college basketball players.

On this day, the Greenspan statement has struck at the heart of the T-bond pit: the "benchmark" 30-year Treasury bond suffers a one-day loss of 1 1/2 points, the biggest price drop in seven months. Many of the "big dogs" howl as prices drop steadily with few chances for recovery. Some traders already held positions or took positions early that morning in anticipation of what the market would do that day. Others would wait, but most of those who had bought at higher prices spend the day frantically looking for the nearest exit, the smallest loss. At moments, "open-outcry" trading looks more like roller derby.

Even if you handle the stress well, fame and fortune can create their own form of anxiety.

"The pressure of the lifestyle is more in defending it," Baldwin says passionately. "Yeah, you can travel here and there and you can buy any car you want, buy any house you want. Once you've done that, then what do you do? Then it becomes, 'Well, I'm supposed to defend it.' Estate planning, taxes, you know, somebody falls down on your property, they sue you. If you're Dennis Rodman [of the Chicago Bulls] and you kick somebody, then you get sued. Well, if you don't have any money and you kick somebody, it's no problem. And because you have money, you get held to a different standard. You become a target. It's very frustrating."

Baldwin's assessment of the pressure is uncommon among traders. Most say that handling the stress is their biggest challenge.

"The stress is tremendous at times. Wouldn't you say?" Dick Friedman is asking his friends while they have breakfast at the Ceres Café on the ground floor of the CBOT building. Friedman is an options trader on the CBOE.

"He's not stressed out at all," responds Neal Shamis sarcastically. Shamis was Friedman's fraternity brother at Indiana University and is also an options trader.

"When you find yourself trading an order and the next thing you know you find yourself down $7,000 in a minute and a half, that's stressful," Friedman emphasizes. "I have lost my hair. I smoke more cigars. I exercise a little bit more than I used to. I find that helps some. But the nice part of this job is--and you gotta learn this early--when the day's done, you gotta leave it at work. And I think most people are pretty good at doing that. I'm fairly good at it. When I go home and see my kids and my wife," he pauses, "or see my kids." Friedman laughs at his own joke. "No, I'm just kidding. You just forget about everything. It's nice. There's not a lot of places, even though you take the risks that you take and the stress that you undergo, there's not a whole lot of places in the world where at the ages we are you can be your own boss. You call your own shots. You're effectively managing your own business."

Friedman, 37, Shamis, 37, and Dan Dougherty, 38, all smoke cigars. "My favorite cigar is the Avo No. 2, which I am pretty religious about," Friedman says. "I really like that. In the summers I switch to the Avo No. 3 because I have time to sit out on my porch at home and enjoy that for a good length of time. During the winter I'm usually confined to my office. I go up to my office to get a break from the stress and sit back, maybe take a look around the Internet, play some games, take an hour and smoke a cigar and relax."

"And you've got your quotes up there so you can stay in touch with your business," adds Dougherty.

"I can watch the markets and what I'm doing," Friedman says. "I can play Trivial Pursuit on-line on the Internet while I'm watching my positions." Even though his office is designated a no-smoking area, Friedman and his co-conspirators have thus far avoided detection. "What we've resorted to is moving the ceiling tile to try and let the smoke escape," Friedman says.

Traders have become expert at finding different ways to relieve stress. While Zawaski spends time at the racetrack, plays golf and has nice lunches and cigars at the Four Seasons, others stay closer to the exchange, crowding into the Off-Track Betting parlor at the corner of Jackson and Franklin. They are looking for action at all times, but don't necessarily want to watch the horses run. Many traders will simply relax at private clubs like the Union League Club, on West Jackson, with its soothing art collection, or the CME Club, at the Chicago Mercantile Exchange, on South Wacker and Monroe.

"Eleven years ago," says Donna Kozak, the former manager of the CME Club, "I don't remember one cigar in here. Five years ago it really picked up." The CME Club allows cigar smoking in the bar, but if more than four people are lighting up, the club moves them to a private room.

No such problem at the LaSalle Club. Located at the same address as the CBOE, the LaSalle Club is a luxurious haunt with state-of-the-art workout facilities, saunas, lap pool with dim lighting, racquetball courts, basketball, aerobics--the whole deal. The hotel has 19 rooms (three of them suites), a cigar lounge and Everest, reputedly one of the two best restaurants in Chicago.

"You'll find that 90 percent of these guys that are here at the club," managing director Richard Gaylord says, "work hard and they play hard. It's kind of unique because they work out hard and then they'll go back and have a great brandy and a cigar. The beauty of it is location. You can walk up here. It's private. We push privacy and exclusivity."

Gaylord, a cigar smoker, says that the club's bar and restaurant, The Buckingham Grill, sells about $1,500 worth of cigars a month. A cabinet humidor separates the bar from the dining room. The bar has a ceiling-high, arch-shaped window looking out onto the Congress Parkway. The place is busy after the close of trading on that particular Wednesday. "Obviously the bad day on the floor is better in the bar," Gaylord offers.

"I guess sometimes before I can do this, I'll go work out," says Rob Schmidt, 35, who trades S&P 500 index options and is sitting in the bar smoking an Avo Pyramid, his favorite, and drinking a Booker's Bourbon on the rocks. Schmidt gets to the gym about 4:30 in the afternoon. He'll work out and make it to the bar by six.

"Then I go home," he puffs. "I find myself a much better husband and father. After this ritual, I know they [wife and children] see a big difference [from when] I come home straight from the trading floor."

Schmidt, like many other traders who've been at it a few years, does not exactly fit the stereotype of the fast-living trader. "I would say that traders have a reputation for liking some of the richer things in life. I would say that leads rather more to cigars and great liquor and all kinds of great entertainment," Schmidt notes, adding that many of his colleagues incorporate that good life with their families.

Paul Johnson, 39, who likes Avo No. 3 and Pleiades, agrees with Schmidt, but points out that the reputation is drawn from younger traders, noting that about 80 percent of those who try to make it as traders don't last. If they last, they usually settle down.

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