But the Koch traders were just like their unionized predecessors in one way. When they got together and drank at the Ginger Man, they bitched about how underpaid they were.
Koch had hired engineers to staff its trading desk, and it continued to pay them like engineers once they learned the job. O’Neill, for example, was still making $60,000 a year. There was a creeping awareness spreading throughout the trading floor that things didn’t have to be this way. There were rumors that traders over at Enron were making multiples of $60,000. And Wall Street banks started calling with job offers that were far richer than what Koch offered.
O’Neill was not a disloyal person. He had worked for Koch his entire career. But financial pressures were beginning to press down on him. His credit card debt, in particular, was problematic. In this, he wasn’t alone. America’s middle class stopped seeing significant pay increases after the 1990s, but they did enjoy a new source of spending power: an easy availability of credit. The loosening of laws around banking during the eighties and nineties paved the way for a flood of consumer debt. At places like nearby Rice University, credit card companies set up booths to greet incoming students, promising easy access to large lines of credit. It had never been easier for Americans to borrow, and they used the privilege to supplement the lag in their paychecks. The tide that lifted all boats during the 1990s was fueled by credit cards that carried 14 percent interest rates or higher. The monthly payments could eat a person alive. O’Neill and his wife were happily married, but that didn’t mean it was easy. They lived within a constricting web of household spending budget. It was hard not to argue when money was tight.
It might have been disappointing, then, to discover that Koch’s trading floor wasn’t an easy path to riches in the mid-1990s. When O’Neill earned $7 million for the company that first year, he might have reasonably expected a large bonus. At the end of the year, he discussed his performance with Sam Soliman and was told that his incentive reward would be $25,000. That was about 0.004 percent of what O’Neill had just earned for the company. Soliman seemed sympathetic to the idea that traders should earn a bigger cut of the profits. But Charles Koch seemed intent on paying the traders like engineers. And O’Neill’s bosses knew that his best annual bonus at the refinery was $10,000 a year.
“Sam’s like, ‘It’s a lot better than the refinery, right?’ ” O’Neill recalled with a laugh. “And I’m like, ‘Yep. Yep. You’re right. It is.’ ”
Not all traders were as compliant. Some of them quietly slipped away to join Enron or big banks. They did so with the knowledge that there were fortunes to be earned. Just seven months after he joined the Gulf Coast Basis desk, Brenden O’Neill got his chance to see this world for himself. He was promoted to trading natural gas derivatives, and ushered into the world of real money.
* * *
Sam Soliman stretched his top traders. When a trader did well at one thing, Soliman tended to promote them into a new role with which they had zero experience. If they performed well in this spot, they could be promoted once again. If not, tap on the shoulder. Good-bye.
Brenden O’Neill was promoted to the natural gas options desk. A natural gas option is a derivatives contract, and O’Neill knew virtually nothing about derivatives before joining Koch’s trading team. He would now be trading millions of dollars a day in contracts. He figured that he’d better learn what he was doing, and fast.
A person couldn’t just enroll in college and take a class in trading natural gas options. O’Neill didn’t take time off and attend Harvard Business School. He didn’t have a mentor, and he didn’t have an industry group that he could turn to for training. So he bought a textbook off the shelf, called Option Volatility and Pricing Strategies: Advanced Trading Strategies and Techniques, by Sheldon Natenberg. It was basically a high-end version of Options Trading for Dummies. He read the book on his own time and started to learn the mechanics of how things worked inside the black box of the derivatives market.
Here is a brief description of a derivatives contract, in one paragraph, that is still torture to read. Pretty much all derivatives traded by people like O’Neill were either “calls” or “puts.” A call is a contract that lets somebody buy something at a certain price. O’Neill could sell you a call that would allow you to buy a tank of natural gas for $5 in March, even if the real price for gas at that time was $10 a tank. It was like an insurance contract against rising prices. He could also sell you a put that would allow you to sell a tank of natural gas in March for $5, even if the real price at that time was $2 a tank. It was like an insurance contract against falling prices.
Again, these derivatives contracts didn’t even deal with real gas. They dealt with gas futures contracts. So, O’Neill was buying and selling insurance contracts on futures contracts. He spent his days examining these futures contracts, and watching their price rise and fall. This was complicated. For natural gas, there were several different futures contracts: there were contracts for delivery of gas in March, then April, then May, then June, and so on. In the eyes of a trader like O’Neill, each month’s contract was like a different commodity in and of itself. The May contract might be doing one thing, while the March contract was doing something different. He examined the behavior of all the different contracts and sold people insurance products—derivatives—for every different month.
O’Neill started experimenting with these new markets. He bought and sold puts and calls options, and then started to figure out more complex maneuvers. He could buy a put on a May futures contract, and then turn around and start buying and selling volumes of that futures contract as a way to hedge the option in a complex interplay that is called trading the “underlier.” It didn’t take long before he realized that these machinations could generate tens of millions of dollars.
Where did all this money come from? Why were the profits so enormous? The best way to understand it is to know that O’Neill was sitting in the middle of a giant game of tug-of-war. On one side of the rope, pulling hard, was every company that drilled natural gas and sold it. This side of the rope wanted gas prices to be as high as possible, because they were selling it. On the other side of the rope, also pulling hard, was everyone who bought natural gas and burned it. These parties wanted gas prices to be as cheap as possible, since they were buying it.
Back and forth these opposing interests tugged, and the bright red line in the middle of the rope was the going price for gas. Sometimes the gas producers were winning the game and pulled the red line way over toward their side, making the price very high. At other times, the consumers won the game and pulled the red line way over to their side, making the price very low. The stakes of this game were almost incomprehensible—the total national market in natural gas was worth several hundred billion dollars a year. When the red line of price went one way or the other, it was the financial equivalent of a tectonic plate shifting in the earth. The rumbling and shaking shook loose billions of dollars in one moment, money that flowed from the pockets of consumers to producers as the price moved positions. And when that money was disgorged, it passed through the hands of traders like O’Neill, who kept a portion of it for themselves. In the final analysis, the people who were buying his derivatives contracts might be a big utility company in Ohio that burns natural gas, or a big company in Oklahoma that drills and sells natural gas. These entities would pay real money for insurance contracts that protected them from shifts in the price. If the price was moving, O’Neill and Koch Industries stood to make millions. Volatility was the trader’s best friend.