March Madness goes to market

When the opening bell sounds at the stock and commodities exchanges around the country tomorrow morning, the traders will be buying and selling the usual products -- crude oil, gold, Treasuries, the S&P 500 index. Off the floor, after the close, they'll also be shorting Duke, going long on Kansas, buying back Pitt, and dumping Alabama. When March Madness begins, Longhorns are just another kind of cattle future.

While millions of Americans will be tossing a few dollars into pick-the-winner office pools on the NCAA men's basketball tournament, the traders will be playing a far more sophisticated game with much more intensity for geometrically higher stakes.

In the commodities world, a contract is an obligation to buy or sell a specific product at a set price on a set date. The contract value goes up and down as the perceived value of the product changes. A Mideast war or a peace settlement will affect the price of oil, a drought or a bumper crop will affect the price of wheat, inflation or deflation the price of gold. If the price goes up, a trader can sell the contract and pocket a profit. If the price drops, he takes a loss.

The same theory applies to basketball teams during the tournament, when perceived value rises and falls with results. A underdog that knocks off a heavy favorite will go up in price. A favorite that goes into double overtime to beat a lightly-regarded team will go down.

The average basketball fan makes bets. The trader deals in futures contracts, which he buys and sells to his peers throughout the tournament, even during a game.

Let's say a participant wants to buy 10 contracts on Boston College winning the tournament title. Traders think the Eagles have a minimal chance, so the price for each contract is low. For each round of the tourney that BC advances, the price goes up. Traders can sell anytime for a profit, but if the participant wants to ''buy more" BC, it will also cost more.

''I attended a massive basketball school," said an options trader who deals in the S&P 500 Index, who like the rest of his colleagues does not want his name used for fear of piquing the interest of the Internal Revenue Service, the state attorney general, and the Securities and Exchange Commission. ''But you get even more rabid interest in the tournament here."

For the next fortnight after the closing bell rings, the members' lounges and bars will be jammed with traders -- nearly all of them male, most of them under 35 -- watching games and monitoring their positions.

In the trading world, everything is (or can be made) a market and all of them have the same characteristics.

''Any market is the sum total of intelligence, paranoia, greed, fear, and idiocy," said a former college basketball player who has dealt in equities and commodities.

All of those elements are at a fever pitch during the NCAAs, which provides several irresistible lures to traders, most of whom are incurable sports junkies who will turn a PlayStation football game run by a computer into a futures market.

March Madness is a single-elimination tournament with 64 teams and a relatively quick expiration date (the final buzzer on April 4), which makes for the volatility that traders crave. ''It's always dynamic," said an options trader who deals in the NASDAQ 100 Index. ''It's not very static."

And you can earn thousands of dollars even if none of your teams makes it to the Final Four, simply by cashing in positions along the way, as traders do with cotton and cocoa contracts every day.

In a standard NCAA pool, participants must fill out the entire bracket and are married to the teams they choose. But traders can buy and sell one or more teams multiple times throughout the tournament or buy and sell the same team at the same time. They can even buy and sell the seeds (all the No. 1s, all the No. 3s), conferences (Big East, ACC) or the four bracket quadrants.

''What's beautiful about trading is that you don't have to hold onto a team," said Edward Kaplan, a Yale professor of management sciences who co-authored a mathematical study of March Madness pools. ''You can sell. You can triple your money."

The way the March Madness market works, teams are priced from 0 to 100, depending on their likelihood of winning the tournament. Illinois, for example, was a 22.2 this week, Wake Forest a 7.3, Connecticut a 4.7, BC a 1.1. The traders determine the prices by what they're willing to pay, with a ''market maker" often serving as middleman. The longer the tournament goes, the higher the prices on the survivors.

If a trader buys 10 contracts on Duke at 8.5, he is paying $85. If Duke wins the tournament, the buyer collects $1,000 for a profit of $915. If Duke loses, he loses the $85 he paid for the contracts. If Duke makes the Sweet 16 and its price goes up to $17, the buyer can sell his position and pocket $85.

''Guys are constantly finagling and taking profits," said a trader who was a market-maker for his colleagues during his days on the Philadelphia exchange.

Trading is all about ''edge," about exploiting the differences in theoretical valuation between teams. Do you think UConn is underbid? Buy it. Do you think Stanford is overbid? Sell. ''The predictable chaos is what's captivating about the tournament," said the S&P 500 options trader. ''There are so many variables, so many strategies, so many opportunities to grind out some edge."

Playing bracket pools is like playing the lottery. ''There are more than nine quintillion possible outcomes," said Kaplan, who has done the math. ''If you count the play-in game, there are 18 quintillion. There are about 6 billion people on the planet. If everyone put in 1.5 billion entries, only one person would get all of the picks right in one draw."

Depending upon how many contracts traders buy, they can make or lose several hundred thousand dollars. The big losses come from selling teams ''short" -- traders selling contracts they don't own on a team in the hope that the team loses early. If it does, the traders make a profit. If the team keeps winning, they have to buy the contract back at a price that can be brutally expensive, or trust in luck.

''One young kid at Paine Webber shorted the hell out of Duke the year that they upset Nevada-Las Vegas [1991] and ended up losing $200,000," remembered a fixed-income salesman. ''Duke ended up beating Kansas for the title, the kid didn't come into work the next day and was never seen again."

In a profession that depends on the honor system, where thousands of dollars exchange hands at the flick of a wrist, failing to pay on an NCAA contract is a major crime. ''This whole business is based on your word being your bond," said the S&P 500 Index trader. ''A few years ago, a guy said he had sold a bunch of Duke when he had bought it. Someone called his boss and he lost his job. Even if his boss hadn't fired him, he would have been a pariah in the pit."

So the market makers who run the NCAA futures are careful to make sure that the players can honor their positions. ''There definitely are risks and, if you're not careful, you can get burned," said the former Philadelphia trader. ''So, when I was doing it, we would only take bets from guys we knew."

The whole idea behind trading is to keep chasing the edge, which changes game by game. Take BC, which probably was overbid when the Eagles were 20-0. Now that they've lost four of eight, they've likely been underbid. But if they make it to the Sweet 16 and Texas upsets Illinois to soften the bracket, BC quickly could be overbid again.

''The guys who do the best are those who gamble the way they trade," said the S&P 500 index trader. ''As opposed to being traders who are gambling."

Most traders will be holding positions on multiple teams, which can mitigate a big loss on one. ''I got my face ripped off on Carolina contracts last year," said the S&P trader, a Tarheel alumnus who admits to betting with his heart. ''But because of how I did with other teams, I only lost $500 instead of $3,000."

Gambling is what they do in Vegas. What they do down around Wall Street is about edge and hedge, even during March. ''Everyone on the Street," said the fixed-income salesman. ''knows about the kid at Paine Webber who shorted Duke."