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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

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BEAT THE MARKET

A scientific Stock Market System

Random House New York

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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

BEATTHE MARKET

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9 8 7

Copyright, 1967, by E. O. Thorp and S. T. Kassouf

All rights reserved under Internationaland 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

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Contents

INTRODUCTION 3

Chapter

1 A SYSTEM IS BORN 7

First venture into the market. The market calls: boardrooms andchartists. 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 twobasic rules relating warrant prices to stock prices. Adjusted warrantsand adjusted exercise price. Reading the financial pages. Checkingthe two rules. The warrant-stock law: predictability in the stockmarket.

3 SHORT SELLING: PROFITS IN BAD TIMES 33

Short selling. Selling warrants short. Molybdenum warrants andthe avalanche effect.

4 THE BASIC SYSTEM 43Hedging: high profit with low risk. Changing the mix. Deeperinsight into the basic system. The basic system: preview. An in-credible meeting.

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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. Howmuch 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 basicsystem. Performance through the 1929 crash.

8 MORE ON WARRANTS AND HEDGING 103

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

9 CAN ANYTHING GO WRONG? 127

Short squeezes. 1929 again? Volatile price movements. Extension ofwarrant privileges. Banning of short sales. Extensive use of the basicsystem.

10 THE GENERAL SYSTEM: THE EVALUATION OF

CONVERTIBLE SECURITIES 141Scope of convertibles. Convertible bonds. Anatomy of a convertiblebond. Reverse hedging with Collins Radio warrants. Picking con-vertible bond situations. Best candidates for reverse hedging. Basicsystem with latent warrants. The basic system with Dresser In-dustries warrants. Finding the best basic-system hedges withconvertible bonds. Convertible preferred stocks. Call options. Puts,calls, and the basic system.

11 DECIPHERING YOUR MONTHLY STATEMENT 169Your brokerage account. The cash account. The margin account.The short account. Calculations in a mixed account. Applicabilityto the basic system.

12 PORTFOLIO MANAGEMENT 181

Exploiting a rise in the price of the common. Exploiting a declinein the price of the common. Diversification? Having several ac-counts. Long-term gains.

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13 WHY WE ARE SHARING THE SECRET 189They wouldnt believe us. I want to do it myself. The threat ofrediscovery.

14 WHAT THE FUTURE HOLDS 195How much can be invested in the basic system? How much can beinvested by the entire system? A general solution for the stockmarket.

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

Contents vii

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BEAT THE MARKET

A scientific Stock Market System

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troduction

We present here a method by which investors can consistently make large profits. We h

sed this method in the market for the past five years to earn 25% a year. We have made p

s during two of the sharpest stock market drops of this century; we have made profits w

e stock market soared; and we have also made profits in stationary and churning mark

We have used mathematics, * economics, and electronic computers to prove and

ct our theory. After reading dozens of books, investigating advisory services and mu

nds, and trying and rejecting scores of systems, we believe that ours is the first scien

ally proven method for consistent stock market profits.

This book analyzes convertible securities and their associated common stock. Th

curities are now held in the portfolios of several million investors. More than 300 of

500 securities traded on the New York and American stock exchanges are convertibles.

ethods apply to these convertibles jointly with their more than 200 associated com

ocks. (We emphasize

* Some of the research which made this book possible is based in part upon mathematical rese

pported in part by Air Force grant AF-AFOSR 1113-66.

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at our profits generally come from both the common stock and the convertibles.) The

f over 500 securities is about 15% of all the securities listed and has a market value of

aps $50 billion.

We predict and analyze the price relationships which exist between convertible sec

es (warrants, convertible bonds, convertible preferreds, puts, and calls) and their com

ock. This allows us to forecast future price relationships and profits. We do not need to

ct prices of individual securities in order to win.

The minimum amount required to operate the system is determined by the am

quired to open a margin account. This amount is subject to change. As we write,

2,000. Our method does not require you to invest all your funds in it, though we expect m

aders will wish to do so. It is natural, for instance, to begin with a trial investment, incr

g it as you gain skill, confidence, and success. If the total equity in your brokerage acc

at least $2,000, then you are free to invest any portion of it by our system, ranging fro

w dollars to the total amount.

We begin the book by telling how we discovered the system. Then, as needed b

round, we discuss warrants, short selling, and hedging. In the fifth chapter we illustrate

ystem with investments made by one of the authors over a five-year period. The sixth c

r shows the reader how to select his own investments with that part of our method we

e basic system. Next we present the historical performance of the basic system, which a

ged more than 25% a year over a seventeen-year period.When the reader finishes the first nine chapters, he can successfully operate his

ock market investments. Chapter 10 shows how to extend our analysis to the entire are

onvertible securities.

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We conclude by discussing accounting and monthly statements, portfolio managem

nd the future for our method.

The scientific proof of the basic system, indicated in the exposition, consists of

arts:

(1) We show (Chapter 7) that the basic system gained more that 25% per year

for seventeen years (after commissions but before taxes). We also show that

when stocks fell from September 1929 to 1930, the basic system could have

doubled an investment.

(2) A statistical analysis, with the aid l basic-system

opportunities from 1946 to 1966 (Appendix E).

(3) Our five-year cash record of no losses and an average return of 25% per

year with the method. One of the authors more than doubled $100,000 in

just four years (Chapter 5).

(4) A theoretical argument that convinced colleagues in whom we confided

(Appendix C).

The tables and charts in the book make our strategy easier to use. For the intere

ader, appendixes indicate the technical foundations for our method. this supplemen

aterial need not be read to successfully employ our winning method.

We do not claim that you can breeze through this book and then shake the money f

ees. This book needs to be studied. However, we intendBeat the Marketto be usefulrofitable to the entire investment public, from professionals to beginners.

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