I reposted this in full because MBA Jungle no longer exists. zg-----------
The House That Blackjack Built
How card whiz Blair Hull parlayed a $25,000 casino stake
into a trading empire worth more than $500 million
by Michael Kaplan | MBA JUNGLE
On a Monday afternoon in 1975, Blair Hull walks into the MGM Grand and draws a $5,000 marker. From all appearances, he’s nothing more than another tourist in Las Vegas looking to try his luck at blackjack. While other players are thinking about which show they might want to see or debating where to go for dinner, Hull is focused on the state of the deck: He keeps track of the cards that have been played and uses that running tally to assess those that remain. He’s calculated that a deck rich in aces, face cards, and tens will give him a statistical advantage over the dealer.
Following a few dull hands, the count of 10-value cards left in the deck increases. Hull has his edge. He begins playing $1,000 chips. Dealt a five and a six to the dealer’s nine, he doubles down, draws a five; the dealer’s got a seven underneath and goes bust with an eight. The $2,000 win is nice, but just as important, the ratio of high cards in the deck has gone up significantly. Hull’s advantage has increased still more. He lays down thousand-dollar chips at two of the table’s positions. He gets four picture cards and splits both hands against the dealer’s six. More highs come his way, and he wins all around. But now, after so many rapid-fire 10-value cards, the deck is burned out. Hull takes his winnings and looks for opportunities at other tables.
Mild-mannered Blair Hull wouldn’t strike you as a slick gambling man. The son of a judge, Hull grew up in the suburb of Los Gatos, California, near Silicon Valley. Known as a geek for carrying a slide rule, Hull thrived in math classes. After earning an MBA from Santa Clara University in 1967, he taught high school math and physics for a year, worked briefly as a securities analyst, sold computer time-sharing, and did linear programming for a company called Kaiser Cement. In 1973, Hull’s then brother-in-law began raving about his blackjack winnings at Nevada casinos. Hull found the claims difficult to believe until he read Beat the Dealer, a classic card-counting primer written by Edward O. Thorp. A mathematical sensibility and the promise of an edge over the house drew Hull to blackjack. “Blair was calm and cool, and nothing bothered him,” remembers Al Francesco, a legendary blackjack player. “He was completely honest and played with pinpoint precision.”
Impressive as Hull was at the blackjack tables, his real jackpots lay ahead. In 1977, he bundled up a $25,000 stake-earned in the casinos—and bought a seat on the Pacific stock exchange, where he first put into practice his own innovative and mathematically complex option-trading system. Eight years later, he launched Hull Trading Company, an operation that in time would handle a significant chunk of the index options traded in the United States. Finally, in 1999, Hull cashed out, selling his firm to Goldman Sachs for more than $500 million in cash, stock, and options.
That’s one tall stack of chips—and, indeed, Hull, 59, a rangy, gray-haired sort whose clear hazel eyes set off his rosy cheeks, readily acknowledges that the blackjack pits served as his finishing school. “Blackjack represented my business and entrepreneurial training,” he says.
Hull’s career brilliantly illustrates the long-recognized nexus between gambling and investing. Back when Vegas was little more than an expanse of sand, economist John Maynard Keynes weighed in on the subject: “The game of professional investment is intolerably boring and over-exacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll.”
Generations after Keynes reached that conclusion, gambling remains a deeply entrenched element of trading culture. Right around the time Hull was plying the tables, a couple of financially savvy physics majors from California built rudimentary microcomputers that attempted to predict the outcome of roulette. Casinos banned the computers before they could be perfected, but the students, Doyne Farmer and Norman Packard, wound up launching the Prediction Company, which earned a reputation for using computer programs to accurately predict stock market movement.
Business professors have also taken a close look at this nexus. Mark Rubinstein of Berkeley’s Haas School of Business, William Ziemba of the University of British Columbia business school, and Donald Hausch of the University of Wisconsin School of Business conducted an exhaustive study of racetrack betting that suggests one can capitalize on market inefficiencies. Indeed, the correlation between gaming and trading is so deep—and in some quarters so well accepted—that the Susquehanna Investment Group in Bala Cynwyd, Pennsylvania, reportedly encourages employees to read Getting the Best of It!, a guide to winning at gambling by David Sklansky.
In fact, small cadres of professional game players regularly drift back and forth across the permeable barrier between the trading floor and the casino floor. Stanford Wong, a pseudonymous card counter and the author of more than 10 books on gambling, holds a Ph.D. in finance from Stanford University and has hosted Q&A sessions at his alma mater under the auspices of finance professor Jack McDonald. "A while back I received a letter from a guy who wanted a job as a trader after spending three years counting cards, so he put card counting on his resumé," says Wong, who occasionally plays blackjack but makes most of his money these days through publishing and sports betting (he loves to find mathematical inefficiencies in proposition wagers). “The man who interviewed him had heard one of my talks and viewed the blackjack experience as a positive. It turned out to be the thing that got him hired, and he wrote to thank me.”
Wong first met Blair Hull back in the ‘70s, when they happened to be using the same strategies at the same blackjack tables at Harrah’s Casino in Lake Tahoe. “Blair had the skills and willpower to be successful,” remembers Wong, who turned down an early opportunity to enter the options business with Hull (“The stupidest decision I ever made,” he laments). Wong says that willpower can present the toughest hurdle—in blackjack and investing—explaining, “If you put out two big bets and get clobbered, even though the deck is favorable, it’s difficult to do it again. But if you want to beat the casinos, you have to do it again.”
That’s a lesson Hull took all the way to the bank. “In blackjack and in the securities market, you have capital fluctuations that are very difficult to withstand emotionally,” he says with characteristic understatement. Over the course of a two-week period in 1981, one of Hull’s traders took a big position on the American Stock Exchange that went horribly sour. Fifty percent of the money Hull had earned over four and a half years evaporated. He says his casino experience gave him the mettle to stick with his otherwise successful trading system, despite the temporary devastation. And, sure enough, he recovered, finishing ‘81 with a profit.
Prudent money management was another skill Hull first honed on the casino floor. “No matter what, you never bet more than one fiftieth of your bankroll, and if you lose, say, half your money, you reduce your bets by half,” he says. “In the securities market, when I had a very large position and knew that we had our maximum amount of risk, I’d still be tempted to make advantageous trades that would come up. But then I’d envision chips on the table and recognize that I already had my bets on.”
Other lessons Hull learned were more subtle. When he played blackjack, he saw it not as a risk-taking endeavor but rather “a clear financial opportunity that other people did not see.” With the right system, blackjack became a positive-expectation game: Statistically speaking, Hull had to win (over the long haul at least). Similarly, he would have been loath to enter the options market without what he perceived as an advantage. At the Pacific Exchange, Hull’s equivalent to card counting was the exploitation of his computer-generated theoretical-value sheets. Based on an option-pricing model of Hull’s own invention (similar to the Black-Scholes model, though he was unaware of their work at the time), the sheets told him what each option was truly worth at a particular stock price—and he would buy or sell accordingly to exploit the spread. The system worked. Hull achieved 400 percent returns on his money in his first two years. Then, with other people using similar strategies—and diluting his advantage as they made similar plays—his annual take dropped to a mere 100 percent.
Like a card counter who’s been made by the casino, Hull felt the need to find virgin territory in which to ply his trade. That turned out to be Chicago, largely because the exchange there was far less technologically savvy than the West Coast’s. “Guys saw me coming onto the floor with the theoretical-value sheets and they laughed; they thought I was a nerd,” Hull remembers, pointing out that card counting taught him to love nothing better than being underestimated. A subtle guy who studiously blends into crowds, Hull adds, “You were supposed to be up there without any aids or you were less than a man.” But to Hull, showboating macho traders were no matter; time spent in the casinos endowed him with a quick technique for sussing out wannabes: “The person who’s showing off, having a big ego, making a big deal about how much money he earns usually is not the person who’s making the most.”
Reading people is an essential business skill, and—with all due respect to Hull and his blackjack buddies—nobody’s as adept at evaluating the other guy as a poker player. Just ask Erik Seidel. Lanky, loose-limbed, and aggressively casual-looking in his favored baggy jeans and untucked shirts, Seidel kicked around college for a few years, made a name for himself on the international backgammon circuit, and in 1985 parlayed his reputation as a wily game player into a job as a Ginnie Mae trader at PaineWebber. These days Seidel is best known as a top-ranked poker player-in the movie Rounders, he’s shown finishing second to Johnny Chan in the 1988 World Series of Poker; last year, Seidel bested Chan in another tournament with a prize of more than $400,000.
Seidel has moved effortlessly between options trading and poker playing, using one career as a hedge against the other. He believes that poker is the tougher of the two vocations, finding proof in the fact that there are thousands of successful traders but only a handful of guys who can make it at poker. Still, the two games have their similarities. “Trading and poker both rely on an ability to not just figure out but to put into effect your analysis of probability—and to do it very quickly,” says Seidel, who claims to have met plenty of MBAs with sufficient technical know-how but not enough gambling sense to fully exploit their techniques. “Different opportunities come up all day long—in the poker room and in the trading room—and they may be good. But how good are they? Taking a position—at a poker table or on a stock—is a gambling decision that requires a lot of patience. On Wall Street you can look at pitches all day long and not swing until it’s the perfect one. That’s one of my strengths. I’m willing to pass on things and play small if I need to— until the perfect situation presents itself.”
There’s also the people game of poker, which easily translates to Wall Street. “At PaineWebber, I had a boss who panicked whenever things started to go badly,” remembers Seidel. “He’d say, ‘Anybody here who’s long is fired.” That was always the buying point. Whenever this guy panicked, it was time to make your biggest plays. I had to do it in a subtle way, but my boss was the most reliable indicator as to where the market was going. That happens in poker all the time. There are situations where somebody loses a critical hand, and you just know he’s about to go on tilt. It’ll be only a matter of time before he’s broke. And that’s the moment when you want to go after him.”
Blair Hull’s critical hand was dealt in 1999, when he began negotiating the sale of his firm to Goldman Sachs, just as he was primed to bring it public. The IPO road show in Amsterdam was weeks away when interest heated up from Goldman—the Wall Street giant realized that it would be more efficient simply to buy an electronic market-maker than to try to create its own. In the planned IPO, Hull’s company was seeking a market cap of $350 million, putting its leader in a good position to turn down initial offers from Goldman; the investment firm, for its part, was particularly drawn to the fact that Hull Trading was a going concern that would run just fine even after Hull himself was out of the picture. “We used to say that you could put a grenade in the company, take out every other person, and we could still go to work tomorrow,” Hull remembers with a wry chuckle.
Four days before the IPO road show, Hull was unsure whether he’d sell to Goldman or go through with the public offering. Before selling, he needed to push Goldman’s offer high enough to make the sale worthwhile. The impending public offering put pressure on Hull’s suitor—but a deal was far from a sure thing. Major players at Hull Trading packed two suitcases: one for New York, one for Amsterdam, planning to go where the action looked the most promising. One day before his date in Amsterdam, Hull closed the deal in lower Manhattan. It was far bigger than any blackjack hand or options trade, but experiences in the two areas had taught Hull to handle fluctuations and stresses, without ruinously chasing money or changing his style of play. “Sticking with your system is so difficult that it explains why there are very few disciplined counters,” he says. “You need to stay in control of your emotions and know that the mathematics will eventually win out.”
For Blair Hull, of course, they did—to the tune of $531 million. But after such a spectacular finale, what do you do for an encore? Encouraged by Chicago’s mayor, Richard Daley, Hull is contemplating a 2004 run for the U.S. Senate in Illinois. He’s a big proponent of women’s rights and expresses a desire to level society’s—and by extension Wall Street’s—playing field. But Hull’s most telling political weapon might be an estimated $40 million campaign budget, which should be intimidating for more than its sheer size: If you know anything about Blair Hull, you know he doesn’t make big bets he expects to lose.