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[Pages:229]Other books by EDWARD O. THORP Elementary Probability Beat the Dealer

Other books by SHEEN T. KASSOUF Evaluation of Convertible Securities A Theory and an Econometric Model

for Common Stock Purchase Warrants

BEAT THE MARKET

A scientific Stock Market System

Random House New York

BEAT THE MARKET

A Scientific Stock Market System

Edward O. Thorp, Ph.D.

Professor of Mathematics University of California at Irvine

Sheen T. Kassouf, Ph.D.

Assistant Professor of Economics University of California at Irvine

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? Copyright, 1967, by E. O. Thorp and S. T. Kassouf All rights reserved under International and Pan-American Copyright Conventions. Published in New York by Random House, Inc., and simultaneously in Toronto, Canada, by Random House of Canada Limited. Library of Congress Catalog Card Number: 67:22624 Manufactured in the United States of America Designed by Betty Anderson

Contents

INTRODUCTION

3

Chapter

1 A SYSTEM IS BORN

7

First venture into the market. The market calls: boardrooms and chartists. The "circus". Fundamentals: the "better" they are, the faster they fall. Textron and Molybdenum. The moment of discov-

ery. Steady profits in bust and boom.

2 WARRANTS: OPTIONS ON THE FUTURE

15

Rediscovery of the system: Ed Thorp under a tree. What is a warrant? Get rich quick? The warrant-stock diagram. The two basic rules relating warrant prices to stock prices. Adjusted warrants and adjusted exercise price. Reading the financial pages. Checking the two rules. The warrant-stock law: predictability in the stock market.

3 SHORT SELLING: PROFITS IN BAD TIMES

33

Short selling. Selling warrants short. Molybdenum warrants and the avalanche effect.

4 THE BASIC SYSTEM

43

Hedging: high profit with low risk. Changing the mix. Deeper insight into the basic system. The basic system: preview. An incredible meeting.

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Contents

5 THE SYSTEM IN ACTION: $100,000 DOUBLES

51

The Molybdenum story. Moly coda. Bunker-Ramo (Teleregister). Catskill conference: Sperry Rand.

6 HOW TO USE THE BASIC SYSTEM

71

Identifying the listed warrants. Picking short-sale candidates. Using the warrant-stock diagram. Which are best? Choosing the mix. How much protection: Dividing your capital among the candidates. Final

points. Summary of the basic system.

7 FURTHER PROOF: THE HISTORICAL RECORD

91

A simplified mechanical strategy. The potential future for the basic system. Performance through the 1929 crash.

8 MORE ON WARRANTS AND HEDGING

103

Over-the-counter, regional, and Canadian warrants. What determines warrant prices? What is a warrant worth? Reverse hedging. Spotting candidates for reverse hedging.

9 CAN ANYTHING GO WRONG?

127

Short squeezes. 1929 again? Volatile price movements. Extension of warrant privileges. Banning of short sales. Extensive use of the basic system.

10 THE GENERAL SYSTEM: THE EVALUATION OF

CONVERTIBLE SECURITIES

141

Scope of convertibles. Convertible bonds. Anatomy of a convertible bond. Reverse hedging with Collins Radio "warrants." Picking convertible bond situations. Best candidates for reverse hedging. Basic system with latent warrants. The basic system with Dresser Industries "warrants." Finding the best basic-system hedges with

convertible bonds. Convertible preferred stocks. Call options. Puts, calls, and the basic system.

11 DECIPHERING YOUR MONTHLY STATEMENT

169

Your brokerage account. The cash account. The margin account. The short account. Calculations in a mixed account. Applicability to the basic system.

12 PORTFOLIO MANAGEMENT

181

Exploiting a rise in the price of the common. Exploiting a decline in the price of the common. Diversification? Having several accounts. Long-term gains.

Contents

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13 WHY WE ARE SHARING THE SECRET

189

They wouldn't believe us. I want to do it myself. The threat of

rediscovery.

14 WHAT THE FUTURE HOLDS

195

How much can be invested in the basic system? How much can be

invested by the entire system? A general solution for the stock

market.

APPENDIX

A Mathematics of the avalanche effect.

199

B Over-the-counter and Canadian warrants.

200

C Scientific proof that hedging can offer high expected return.

200

D The prediction of warrant prices.

201

E Basic-system hedge performance, 1946-1966.

204

REFERENCES

209

INDEX

213

BEAT THE MARKET

A scientific Stock Market System

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