Specifically, we’re hearing that the smart money KNEW Bernie had to be cheating, because the returns he was generating were impossibly good. Many Wall Streeters suspected the wrong rigged game, though: They thought it was insider trading, not a Ponzi scheme. And here’s the best part: That’s why they invested with him.
For years and years I’ve heard people say that [Bernie’s] investment performance was too good to be true. The returns were too steady – like GE earnings under Welch – and too high given the supposed strategy.
One Madoff investor, himself a legend, told me that Madoff’s performance “just doesn’t make sense. The numbers can’t be straight.” Another sophisticated Madoff investor actually went through trade confirms in order to reverse-engineer the strategy and said, “it doesn’t add up.”
So why did these smart and skeptical investors keep investing? They, like many Madoff investors, assumed Madoff was somehow illegally trading on information from his market-making business for their benefit. They didn’t consider the possibility that he was clean on that score but running a good old-fashioned Ponzi scheme.
And another from Whitney Tilson:
One friend who saw this coming said Madoff had his own broker-dealer and a relative as his finance guy; another friend said he was suspicious because of the 1-2%/month returns with never a down month (much less quarter or year), combined with never showing a a down month (much less quarter or year), combined with never showing anyone his portfolio. 99% of the time, if it sounds too good to be true, IT IS!
You could lose if you apply the collar (buying a given stock, then selling a call option and using the premium from that option to buy a put optio); it is not an arbitrage strategy. The collar does have a downside though, although it is limited download. The upside is limited too. Even firms such as LTCM who thought they were receiving free money (largely through fixed-income trades) lost big when a 20 sigma event (20 standard deviations above the mean) happened (e.g. Russia defaulting on its debt in 1998).
I do not think such a strategy is capable of given such consistent returns.