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Having found himself barred from casinos after his success at the blackjack tables, Thorp went on to apply his energies to financial markets. In 1969, he teamed up with a young New York stockbroker to form Princeton Newport Partners (PNP), an early quantitative hedge fund that went on to produce compound annual returns of almost 20 percent net of fees until it was wound up in 1989.ssss1 PNP's extraordinary success was owed to its ability to exploit statistical mispricing of derivatives through arbitrage strategies. Academic honours for the model that accurately priced derivatives would go to others, while Thorp quietly made a fortune for himself and his investors.

The maths for calculating a derivative's price are based on four factors: the price of the underlying asset; the length of time until its expiry date; market interest rates; and volatility. If all of these quantities are known, then the price of a derivative instrument can be calculated with scientific accuracy. However, while the price of the underlying asset, duration and interest rates can be known, future volatility is a prediction based on historic experience. Traders who forget that the past is not always a good guide to what will happen in the future often suffer catastrophic losses. Ironically, Robert Merton and Myron Scholes, the academics who shared the 1997 Nobel Prize in economics for inventing the famous Black-Scholes model for pricing options, learned this lesson the hard way. Just a year after their Nobel award, the hedge fund Long-Term Capital Management (LTCM), in which they were partners, had to be bailed out by Wall Street banks under Fed supervision after suffering spectacular losses.ssss1