Bernard Madoff was either the most ethically void individual or he just had no regard for ethics. He managed to pull off one the largest Ponzi scheme in history with very little help. He had a legitimate stock trading business on one floor and his illegitimate investment management business was on another floor (Ferrell, Ferrell & Fraedrich, 2011). The top executives in the company were family which leads to the question, did they really not know? This paper will examine the origin of the Ponzi scheme, a brief history of Bernie Madoff, and the fallout as a result of his fraudulent business. A Ponzi scheme is “a fraudulent investment operation that pays returns to investors out of the money paid by subsequent investors rather than
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It was this experience that gave Bernie the ability to develop his fraudulent investment advisory business. Madoff’s reputation as a knowledgable investment professional as well as the allure of an “exclusive” investment opportunity fueled the companies success. The strategy used in the Madoff scheme is referred to as the split-strike conversion strategy. Gregoriou & Lhabitant (2009) explain the strategy as follows:
Buy a basket of stocks highly correlated to the S&P 100 Index,
Sell out-of-the-money call options on the S&P 100 with a notional value similar to that of the long equity portfolio. This creates a ceiling value beyond which further gains in the basket of stocks are offset by increasing liability of the short call options; and
Buy out-of-the-money put options on the S&P 100 with a notional value similar to that of the long equity portfolio. This creates a floor value below which further declines in the value of the basket of stocks is offset by gains in the long put options.
Although a split-strike conversion strategy can be profitable over a long period of time, there are normally down months as well as periods of volatility. In the case of Madoff there were only 10 down months out of the 215 and very little volatility (Gregoriou & Lhabitant, 2009). This should have been a red flag since no other manager using the same strategy was able