How Charlie Geller and Jamie Shipley Made Millions with an Initial Investment of $100,000

In the movie The Big Short, Charlie Geller and Jamie Shipley, two young investors, are depicted as revolutionaries who made millions from an initial investment of $100,000 by exploiting the financial weaknesses in the housing market during the 2007-2008 financial crisis. This article will provide a detailed breakdown of their strategy and the financial instruments they used to capitalize on the impending market collapse.

Identifying the Market Flaw

Geller and Shipley recognized that the housing market was built on a shaky foundation of subprime mortgages. These risky loans were vulnerable to default, and Geller and Shipley identified this as a significant weakness in the market.

Buying Credit Default Swaps (CDS)

They approached a larger investment firm where they learned about credit default swaps (CDS), essentially insurance policies against the default of mortgage-backed securities (MBS). The key to their strategy was to invest in CDS contracts, betting against the housing market.

Leveraging Their Investment

With their initial $100,000, Geller and Shipley purchased a large amount of CDS contracts. The financial leverage inherent in these instruments allowed them to control much larger sums of money than their initial investment. This strategy multiplied their potential profits, turning a small initial investment into substantial returns.

Market Collapse and Profits

As the housing market began to collapse and mortgage defaults increased, the value of the CDS skyrocketed. The contracts they purchased became extremely profitable as the very securities they bet against plummeted in value. Eventually, they sold their CDS contracts for a substantial profit, turning their $100,000 investment into millions.

Understanding Financial Instruments and Pricing Models

The success of Geller and Shipley's strategy was not just about identifying market flaws but also about understanding the underlying pricing and valuation models used by big banks. They used financial instruments like options to capitalize on the unpredictability of certain market events.

Using Options for Profit

An option is the right to buy or sell a stock at a certain price in the future. Geller and Shipley used this concept to their advantage. For example, if Apple's (AAPL) stock is currently at $110, and they predict that in one month it will be at $130, they could buy options from an investor who has a substantial position in AAPL shares. These options allow Geller and Shipley to buy 100 shares at $120 in one month. If AAPL reaches $130, they can immediately sell the shares and make a profit of $9 per share ($130 - $120 - $1 contract price). If AAPL fails to reach $120, the options expire without any profit, but the premium paid ($1 per share) is kept by the seller.

Option Pricing and Probabilities

Option pricing is based on the probability of a stock reaching a certain price. Small movements are much more likely than big movements. Therefore, options predicting small movements are priced higher. In the case of a company involved in a major court case, the likelihood of a significant share price movement is high. If the company loses, the shares will be worth little; if they win, the shares will be worth much more. Big banks priced these options the same way they priced all options, making it possible for Geller and Shipley to accumulate a massive position for just a few thousand dollars.

By identifying companies in this position, Geller and Shipley were able to smartly amass long-term options that would pay off huge if the court case settled in the timeframe they predicted.

Conclusion

The story of Charlie Geller and Jamie Shipley highlights the importance of understanding market flaws and using financial instruments to capitalize on impending crises. Their strategy involved identifying market weaknesses, leveraging financial instruments, and understanding pricing models. With careful analysis and strategic investment, they were able to transform a small initial investment into a significant profit.