JPMorgan Chase & Co's losing bets in credit derivatives were so huge that one of its traders was known as "the London whale" and the hedge funds that attacked him have often been portrayed as harpooners who made a killing. But the story, it turns out, is more complicated than that.
According to hedge fund managers and traders close to the struggle, the bank's losses - more than $2 billion - may not lead to stunning returns for the funds that were on the other side of the transactions.
At least some of the funds that ended up buying credit derivatives from JPMorgan were using them to reduce risk, not make outright bets on the market.
Any gains that funds received from these positions would have been offset by losses elsewhere in their portfolios, as the stock market has plunged in recent weeks and corporate bonds have also weakened.
Some investors did make outright bets that the credit picture would deteriorate, but many kept their positions small, because they feared being crushed by JPMorgan's trading power.
"I don't think you're going to see a lot of hedge fund portfolio managers buying Ferraris this year with profits from this trade," one hedge fund manager said.
Consider Saba Capital. The fund's head, Boaz Weinstein, famously recommended at a presentation in February that investors use derivatives to bet against what is essentially a basket of corporate bonds, in what later emerged as the opposite of JPMorgan Chase's trade.
Recent press coverage of Weinstein's strategy has suggested he made a mint. For example, the New York Post, in a story about his purchase of a $25.5 million Manhattan apartment, reported on Thursday that he had "profited wildly" from the trade.
But the other half of Weinstein's recommended trade was to buy equities, according to a person at the presentation in New York. Weinstein said that because the bet against the basket of corporate credit was so cheap, it could also be used as a hedge against other exposure, such as a portfolio of corporate bonds.
Even if the bet against corporate bonds has performed well since the end of March, the bet on equities has likely weakened, because the Standard & Poor's 500 index has fallen more than 7 percent so far this quarter, said the person familiar with the presentation.
Saba declined to comment on Weinstein's presentation, its performance or its trading positions. JPMorgan declined to comment.
The hedge fund's recommended trade would pay off if either corporate bonds and their associated derivatives weakened as the economy slowed, or equities got much stronger as the economy accelerated.
With Europe's debt difficulties intensifying and the U.S. recovery showing signs of sputtering, credit markets have weakened.
The corporate credit index that Weinstein was betting against has moved more than 25 percent in his favor since the end of March, according to data from Markit, which could translate to much bigger gains than the losses from the equity portion of the trade.
This has led to the JPMorgan loss, which some traders say could climb to as much as $5 billion once the trade is completely unwound over the next few months. The "London whale" - French trader Bruno Iksil - still works for the bank, though his long-term career there is obviously in question.
Without knowing the size of the two parts of the trade, it is impossible to figure out how much the Saba fund gained. But its main fund is up only about 2 percent for the year, according to an investor, which does not look like the performance of a fund that bet the farm on beating JPMorgan.
That modest gain is a far cry from hedge fund manager John Paulson's famous bets against the subprime mortgage markets that powered gains of about 600 percent for one of his funds in 2007.
To be sure, some fund managers say they did make outright bets against JPMorgan or know managers who did. Those managers may end up making decent returns.
But many investors took relatively small positions because they hesitated to face off against JPMorgan, which given its massive resources could clearly distort the market for some time. That timidity will also limit funds' gains from the trade.
"When you make a trade, you have to assume it can go against you before it goes for you, and you size your trade accordingly," one credit hedge fund manager said.
JPMorgan was using derivatives to essentially sell insurance against groups of credits defaulting. The bank's position performs well if fears of corporate defaults start to abate, or at least hold steady.
The bank does not seem to have cashed out of much of its position yet, if any, according to credit traders, meaning that so far it mainly has paper losses rather than realized losses.
The funds on the other side -- those buying insurance against credit defaults -- believed they were getting a good deal. Because JPMorgan was selling so much credit protection, investors could buy insurance on one portfolio for about 21 percent less than the cost of insuring all the credits individually, making it a real opportunity for many investors to cheaply hedge.
"We noticed that price discrepancy, because it was big," said one New York hedge fund manager, who used the trade to hedge against credit risk in his portfolio.
Some were betting that the price anomaly in the market would disappear. Dealers offered trades that allowed investors to bet that the discrepancy between the theoretical value of index and its actual value would go away, the credit hedge fund manager said.
One of the portfolios of credits that JPMorgan bet on, known as the Markit CDX NA IG Series 9 index maturing in 2017, started trading at a big discount to its theoretical value last autumn. Trading volume in the index really jumped in January and February. Investors believe that around that time, JPMorgan allowed a trade that used the index to turn from disaster insurance into an outright bet on credit markets improving.
(Additional reporting by Svea Herbst in Boston; Editing by Alwyn Scott, Martin Howell and Steve Orlofsky)