football Unbelievable Calls

Eight days after the Super Bowl, NFL fans worldwide are still talking about that play call. With 2nd and goal at the Patriots one-yard-line, trailing 28-24 with less than a minute on the clock, the Seahawks had strong alternatives at their disposal. Their powerful running back Marshawn Lynch, nicknamed Beast Mode for his ability to run through would-be tacklers, had bulldozed to more than 100 yards in the game already. Their ever-elusive quarterback Russell Wilson had slipped through the fingers of blitzing defenders more than once. Run a single yard, and their opponents would fall behind with less than thirty seconds to kick a game-tying field goal.

Instead, the Seattle coaching staff stunningly selected a slant pass to their wide receiver, Ricardo Lockette, whose route would take him straight into the heart of the densely-concentrated Patriots run-stopping defense. The pass never arrived. Rookie cornerback Malcolm Butler jumped the slant route, knocked Lockette from the spot, and intercepted the ball, thereby deflating the Seahawks’ hopes of repeating as champions.

Skilled commentator Cris Collinsworth erupted in surprise. “I can’t believe the call. You have Marshawn Lynch … a guy who’s been borderline unstoppable. I can’t believe the call.” Football stars weighed in rapidly on Twitter with similar responses. “That was the worst play I’ve seen in the history of football,” groaned Emmitt Smith, all-time leader in career rushing yards. “Give the ball to #BEASTMODE in that situation. #FEELBAD4THEPLAYERS,” emoted wide receiver Terrell Owens.

While Seattle dealt with the consequences of their decision honorably – the head coach, offensive coordinator, and quarterback each separately took the blame for the interception – the question remains: was it the right call? Statistically, Seattle was like the majority of NFL teams this season, in that a higher percentage of its turnovers came from interceptions (versus fumbles) than would have been predicted by pass versus run selection. Given that fact, did the perceived benefits of calling that particular play justify the increased turnover risk of passing over the middle instead of running?
Of course, the Seahawks aren’t the only ones rueing the day they made a risky call that went against them. Last month, Citigroup lost around $150 million in one day’s trading after the Swiss central bank stunned markets by dropping its EUR-CHF peg. With no central bank to prevent Swiss franc appreciation, it sped from 1.20 CHF per EUR to 1.00 in minutes! Retail FX websites offering leverage as high as 50 to 1 became insolvent, and major trading banks lost hundreds of millions of dollars.

But the day’s enormous swing was especially painful for Citi, because it had allowed its hedges against CHF appreciation to expire only one week before! While the bank sold CHF call options (which would benefit from an appreciated franc), it declined to retain offsetting trades that would have protected its downside. Further, standard currency options gain from greater volatility, and volatility nearly quadrupled that week, compounding the liability on Citi’s sold options. No wonder certain financial commentators considered the bank’s choice to let hedges lapse an “unbelievable call.”

So how can you avoid the hedging equivalent of an unbelievable call?

(1) Never assume a recent history of inactivity will persist. The Swiss franc spent 2012-2014 within the narrow boundary of 1.26 to 1.20 per Euro, but it took only one day in 2015 to drop from 1.20 to 1.00! Given the Swiss franc’s recent stability, the temptation not to insure against sudden appreciation eventually became too strong for some firms, costing them a fortune when the peg broke. That same temptation lurks at the door of floating-rate borrowers who haven’t hedged their borrowing costs, simply because 1-month LIBOR has been less than 1% for the past six years. A recent history of inactivity cannot be presumed to continue indefinitely.

(2) Consider all the relevant risk management variables. Seattle’s coaching staff needed to weigh a number of variables to make its final play call, including the time on the clock, their remaining timeouts, and the defense New England was showing. Similarly, thoughtful risk management decisions depend upon weighing all pertinent variables carefully, asking such questions as: What is my overall tolerance for risk? What is the time horizon I am targeting? What does the shape of the forward curve portend? What exogenous geopolitical occurrences could shock the underlying asset’s price?

(3) Understand the limits of risk-prediction models. Citi and many other major FX traders deploy value-at-risk models, to clarify how much of the firm’s capital is in jeopardy based on certain probability-weighted rate swings that might occur. Among other inputs, such models typically rely upon market volatility – but what happens when 1-year market volatility in EUR-CHF goes from 4% on January 12th to 16% on January 16th? The models will update to incorporate the new volatility data prospectively, but too late to preempt a nine-figure loss. Unfortunately, models haven’t historically done well with predicting black swan events associated with depegging — like when the European Monetary System broke apart under speculative attack in September 1992 – and they may not be correctly reflecting current risks of the Danish krone’s euro peg’s succumbing to speculative pressure.

(4) Always stay in touch with your friendly risk management advisor. We don’t merely want to help our clients prevent making “unbelievable calls” in hedging; we want to see you win the world championship of risk management. So give us a call (of the believable kind)!