Account Five Eights in Singapore

Nick Leeson, Short Straddles, and the Earthquake That Brought Down Barings Bank

Cleaning staff in Room 1106 of the Regent Hotel in Kuala Lumpur found an abandoned keycard on February 23, 1995. On the desk lay a brief handwritten apology note. Its author, Nick Leeson, the general manager and head floor trader for Barings Futures Singapore, was boarding a flight to Borneo and then Frankfurt while auditors in Singapore pried open his locked filing cabinets. Inside Barings' computer system sat a client error account numbered 88888, chosen because eight is a lucky digit in Chinese numerology. That single file concealed £827 million ($1.3 billion) in unhedged derivative losses. Within forty-eight hours, it wiped out 233-year-old Barings Bank, the oldest merchant bank in London and personal banker to Queen Elizabeth II.

Leeson had arrived on the floor of the Singapore International Monetary Exchange (SIMEX) in 1992 with a narrow, low-risk mandate. His job was to arbitrage tiny price discrepancies in Nikkei 225 stock-index futures between the open-outcry pit in Singapore and the electronic exchange in Osaka. Because Barings failed to separate trading from back-office settlement, Leeson served simultaneously as chief floor trader and head of accounting operations. As Leeson later recounted in his memoir of the collapse, executives at the London end of Barings projected such omniscient confidence that nobody dared ask a basic question for fear of looking foolish in front of colleagues.

When one of his clerks accidentally bought twenty Nikkei futures contracts instead of selling them on July 17, 1992, creating a £20,000 loss, Leeson hid the trade inside error account 88888 rather than reporting it to London. Discovering that he could book losing trades to 88888 while crediting offsetting fictitious gains to his public trading accounts, Leeson began doubling down on directional bets whenever the Tokyo market moved against him. By the end of 1993, hidden losses inside 88888 reached £23 million. By December 1994, they hit £208 million, even as London executives paid Leeson a £130,000 bonus and praised him for generating a fifth of Barings' global profits.

Holding thousands of losing futures contracts on SIMEX required wiring hard cash to the exchange clearinghouse every morning to meet variation margin calls. To raise upfront cash without asking London for every yen, Leeson turned to selling Nikkei 225 option straddles. A short straddle consists of simultaneously selling a call option and a put option at the exact same strike price $K$ and expiration date $T$, collecting the combined upfront premiums $P_{\text{call}} + P_{\text{put}}$. At expiration, the seller's net payoff $\Pi(S_T)$ as a function of the final index level $S_T$ is:

Selling straddles is a pure bet against volatility. If the Nikkei index stays pinned near the strike price $K$ ($18{,}500$ to $19{,}500$), the trader keeps the upfront cash premiums to pay his futures margin calls. If the index moves sharply in either direction, however, losses grow linearly without bound. By January 1995, Leeson had sold roughly 37,000 short straddles—74,000 option contracts—turning Barings into the primary volatility insurer of the entire Japanese stock market.

At 5:46 a.m. on Tuesday, January 17, 1995, a magnitude 6.9 earthquake struck Kobe, Japan, destroying ports, highways, and over one hundred thousand buildings. As the Nikkei 225 dropped more than a thousand points over the week of January 23, Leeson suffered a double hemorrhage. His short puts exploded in liability under $-|S_T - K|$. In a desperate attempt to push the entire Japanese stock market back up into his $19{,}000$ straddle cone, he bought 61,039 March Nikkei futures contracts—half the open interest on SIMEX—while tricking London treasurers into wiring £500 million to cover bogus client loans. When the Kobe earthquake knocked the Nikkei index down past eighteen thousand points, Leeson's unhedged futures and option losses reached £827 million—twice the entire equity capital of 233-year-old Barings Bank, which was sold to ING for one pound.