Leeson’s main activity at Barings was futures “arbitrage”: trading contracts on the Nikkei 225 -an index of Japanese stocks -in both Singapore and Osaka to take advantage of small price differences between the two markets. This is normally a low-risk business, with little prospect for big gains or glory.
In the second half of 1994, Leeson apparently departed from that strategy and began selling futures options in a “straddle,” a far riskier bet that the Nikkei would stay within a certain range. After the Kobe earthquake on Jan. 17, the Nikkei plummeted more than 1,000 points, leaving Barings with a huge loss.
Instead of withdrawing from the market and cutting his losses, Leeson started to purchase vast amounts of a Nikkei contract expiring March 10, apparently hoping to bolster the value of his positions.
He also “shorted” futures on Japanese interest rates and government bonds, selling contracts Barings did not own. The hope may have been that if the Nikkei fell, the value of the shorted futures would rise, creating a hedge against losses, As the Nikkei kept falling, Barings put up nearly $900 million to back its falling positions. Much of that apparently came from Barings’s London headquarters.
By the time Barings failed on Feb. 26, it was holding more than $6 billion in March Nikkei 225 futures and was short $20 billion in Japanese bond and interest-rate futures. Its loss On these sitions: more than $1 billion.
