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Wiley Series in Financial Engineering
Series Editor: Jack Marshall

Managing Director of the International Association of Financial

Engineers

Structured Financial Products

John C. Braddock

Derivatives for Decision Makers: Strategic Management Issues

George Crawford and Bidyut Sen

Interest-Rate Option Models

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Derivatives Handbook: Risk Management and Control

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Dynamic Hedging: Managing Vanilla and Exotic Options

Nassim Taleb
MANAGING VANILLA AND
EXOTIC OPTIONS

Nassim Taleb
Preface
After closing about 200,000 option transactions' (that is separate option
tickets) over 12 years and studying about 70,000 risk management
reports, I felt that I needed to sit down and reflect on the thousands of
mishedges I had committed.

I clambered up to my attic where, during 6 entire months, I spent 14

hours a day, 7 days a week, immersed in probability theory, numerical
analysis, and mathematical statistics (at a Ph.D. level). Then I began to
write this book.

Like George Soros2, I believed in a greater uncertainty principle

(more acute than Heisenberg's) that largely invalidates social science
theories based on physics-like methodology and weakens the notion of
modeling outside of the natural sciences. It ain't physics, I kept warning
my trainees throughout my career.

My other argument against being scientific was that, even if it were a

"science," option theory (while perhaps on the right track) would be too
young to be reliable. I then needed to warn the public (and the
regulators) against taking an unseasoned and new field and applying
some of its still misspecified models to reality. Many of the market risks
that have been well known to traders since imperial Rome (like
squeezes and the snowballing liquidity holes) have not yet been
rediscovered by the scientific risk managers. I am convinced that the
financial system is largely threatened by the proliferation of risk
management advisory services run by former scientists who bullied
their way into financial markets. My intention was to downgrade
hedging and risk management from the status of science to that of a
craft, until further notice.

This book is about hedging the risks of standard and exotic options,
as part of the larger framework of risk management. No road map was
available since little has been written on this subject (in contrast to the
extensive literature for valuation).

Dynamic hedging is more like medicine than biology. It is learned by

gaining practical experience as well as by studying published research.
The wrinkles of the marketplace often dominate other complex issues,
which can lead option theoreticians onto a wrong path. Traders' lore can
only be transmitted through practice. This book will meld matters of
practical (not necessarily anecdotal) importance with fundamental
theory.

The major theme is to present traders and risk managers with the
tools to navigate around the difficult notion of manufacturing financial
products through book-running. This book will introduce the arcane
world of dynamic monitoring of risks. The core of dynamic hedging
includes:

• The need for a methodology for the implementation of the Black-

Scholes-Merton3 replicating process for options or any other
nonlinear security under the constraints imposed by the marketplace.

• The need to generalize the Black-Scholes-Merton framework to cover

other parameters than the underlying security in the replicating
process (like volatility or interest rates).

• The awareness that transaction costs and frequency can cause a

departure from the canons of continuous time finance.

• The awareness that distributions are unstable and hard to model.

Much of the common option literature has been concerned with

details of the pricing of instruments (some of which remain
untractable).4 These works often provide insignificant answers to
insignificant problems, such as the search for precision in the pricing of
American options with constant volatility or interest rates (penny
wisdom and dollar insensitivity). In addition, the nontheoretical option
literature, departing from the Black-ScholesMerton framework, has
been ensconced in static risk measurement. Most documents
introducing traders to conventional risks show only the static, not the
dynamic, risks. A derivatives position that is dynamically hedged will
be subjected to an entirely different risk profile and, given the
limitations of such hedging, will therefore be subjected to path
dependence (a key word for an option manufacturer).

Readers will not find a magazine-type proliferation of traded exotic

structures that delineate infinite variations and combinations; instead,
the analysis is limited to the nondecomposable structures (the SDF,
smallest decomposable fragment). A structure that is the addition of two
products will be therefore excluded (except in few cases of
nonadditivity, where the combination has some merit for the dynamic
hedger). The objective of this book is to provide the traders and risk
managers with the tools, not the ramifications.

Readers should use this book like a roadmap, searching out topics
that interest them and moving freely from topic to topic. The formal
definitions serve as anchors between categories.

More advanced mathematical topics are relegated to the modules at

the back of the book. An attempt has been made to avoid mathematical
language and to explain issues in plain English. Formulas do not appear
until Chapter 22. In addition, in the presentation of mathematical
elements, the book avoids the measure-theoretic framework (required
for most proofs in probability theory) and follows an intuitive path.
Most mathematical concepts surrounding the topic can be explained
with an intuitive verbal description accompanied by graphical hints.

Option Wizards provide a lighter note for many serious topics. Since
these sections are designed to be read independently, readers can flip
between them at their discretion.

Finally, throughout this book, the pronoun he is used as a stylistic

convention for ease of reading. This use should always be construed as
gender neutral.
• Part I (Chapters 1-6) defines market microstructure and products. The
markets are viewed from the vantage point of broker speaker boxes
and market pits, but also are defined in the formal setting of market
microstructure theory.

• Part II (Chapters 7-16) defines the basics of vanilla option risk and
presents measurement tools.

• Part III (Chapters 17-23) describes the risks of exotic options.

• Part IV (Modules A to G) presents more quantitative tools of analysis

and bridges a practitioner's world with option theory. These modules,
however, should not be construed as appendixes: Most of their
content belong to the core of the text.

NOTES ON THE TEXT

Given that I did not initially learn about options in the literature but
directly from the market (through observation and experimentation),
most of my reasoning remains highly intuitive. I apologize to people
with more scholastic tastes who may not be used to such a presentation.
Most examples in this book are presented as generic situations. The
volatility will be defined as 15.7% (to make one standard deviation
equal to 1% daily move). The markets will be scaled to trade at 100.5
For the purposes of pure option situations, the forward is equal to spot,
and the financial carry is insignif icant (except in the rare difficult cases
where it matters). All options will be European style except for the
exotic options where a term structure may be introduced if it becomes
relevant for the exercise.

Showing the profile of a butterfly, for example, will involve using

98/100/102 generic calls and studying a calendar spread looking at the
three-month 100 against the 6-month 100 calls, and so on.

The creation of generic examples will standardize all cases and help
in equating situations throughout the book. When dealing with a purely
conceptual option problem, it is necessary to strip out the underlying
particularities. Optionality transcends the details in most cases. Where
these particularities are essential, we will revert to a singular example
taken from a specific market.

Notations
 Jargon

Many terms may be linguistically ambiguous for people from outside

the industry. Even option books written for practitioners do not seem to
pick up our vernacular.

The same designation delta is used for both the rate and the total
equivalent exposure (rate times face value). The same for gamma, vega,
theta, and other Greeks.

By "volatility" is always meant implied volatility, not historical. By

"15 volatility" read 15% implied volatility for the instrument in
annualized terms.

By "underlying" is meant underlying asset, which is also called spot,

cash price (as opposed to forward or future).

By "50 cents price" for an option is always meant.5% of face value.

By "1 dollar" is meant 1%. By "tick" or "pip" is meant .01% of face
value.

By "long the 100" read long the 100 strike.

By "shorter" and "longer" option read "option with shorter time to

expiration."

By "leg" is meant one side of a trade in a strategy.

By "Black-Scholes-Merton" is meant the Black-Scholes-Merton

option valuation model, as well as its extensions to more complex
securities.

By "stopping time" or "first exit" read expected stopping time or

expected first exit time.

By "high correlation matrix" read a correlation matrix with most

parameters close to 1.
 By "integral" is often meant stochastic integral. By "sensitivity to a
parameter" is meant comparative static sensitivity to a parameter
change. By "the delta vanishes asymptotically" is meant that the delta
vanishes asymptotically to the asset price.

By x/2 y is meant (x/2) y and a + b/2 means a + (b/2).

Finally, the term derivative, can mean either a derivative security or

the mathematical rate of change. When possible, the text will specify if
it is a mathematical derivative; otherwise it should be construed as
being a security.

NASSIM TALEB

Larchmont, New York

November 1996
Acknowledgments
This work reflects the help and knowledge of many. First, I want to
thank two people who participated in every phase of the manuscript's
development: Raphael Douady, a mathematician and Howard Savery,
an exotic options trader. Both have extremely intuitive and fast minds.
They asked me to adopt a language that would be neutral enough for
both to understand. Many of the ideas of the book were discussed and
belabored to the point of my being incapable of distinguishing between
my original ideas and the ones that they suggested to me. Raphael, in
addition, composed an academic paper on stopping time (in French no
less) to help with some of the pricing tools for the book.

The pedagogical method of defining the issue and explaining it

intuitively prior to expanding any point was inspired by the coaching
of Marty O'Connell and Jim Piper with whom I, along with Richard
Laden, gave a series of seminars on simple methods for hedging
complicated options.

The following people either generously reviewed sections of the

manuscript and offered comments or discussed some of the topics with
me. Nicole El Karoui, David DeRosa, Marco Avellaneda, Dean Weaver
(who detected the highest number of undetectable typos), Peter
Tselepis, Jamil Baz, Stan Jonas, Yuri Gonorovsky, Bob Freedberg,
Steven Monieson, Doug Monieson, Brian Monieson, Scott Kerbel,
Antonio Paras, Bob Whittacre, Didier Javice, Richard Laden, Dan
Mantini (who detected the first misplaced decimal), Shivagi Rao,
Richard Kates, Jimmy Powers, Nick Hatzopoulos, Jean-Philippe
Frignet, Rick Welsh, Leon Rosen, Shaiy Pilpel, Tony Glickman,
Andrei Pokrovski, Julian Harding, Philibert Kongtcheu, Maroun Edde,
Bruno Dupire, David Donora, Helyette Geman, Bill Margrabe, Henry
Zhu, Ram Venkatraman, Nakle Zeidan, Marc Weissman, Thomas
Artarit, and Michel Jean-Baptiste.
 All mistakes that have been overlooked are mine. I would also like
to thank Pamela van Giessen, my editor at Wiley, as well as Mary
Daniello, the book's production manager at Wiley, and Nancy Marcus
Land, at Publications Development Company.

For any inadvertent omissions that emanate from my

absentmindedness, I apologize. Please accept my unspoken thanks.

Data were provided by Banque Indosuez, Steve Monieson, Tradition

Financial Services, and Pierre Wolf.

N. T.
Contents
Introduction Dynamic Hedging 1

Principles of Real World Dynamic Hedging 1

General Risk Management 3

PART I

MARKETS, INSTRUMENTS, PEOPLE

1 Introduction to the Instruments 9

Derivatives 9

Synthetic Securities 12

Time-Dependent Linear Derivatives 13

Noncontingent Time-Dependent Nonlinear Derivatives 16

Options and Other Contingent Claims 16

Simple Options 18

Hard and Soft Optionality 20

Basic Rules of Options Equivalence 20

Mirror Image Rule 22

American Options, Early Exercise, and Other Headaches

(Advanced Topic) 24

Soft American Options 24

 Hard American Options 25

A Brief Warning about Early Exercise Tests 27

Forwards, Futures, and Forward-Forwards (Advanced Topic) 29

Credit 30

Marks-to-Market Differences 30

The Correlation between the Future and the Financing (Advanced

Issue) 31

Forward-Forward 32

Core Risk Management: Distinction between Primary and

Secondary Risks 32

Applying the Framework to Specific Instruments 35

2 The Generalized Option 38

Step 1. The Homogeneity of the Structure 38

Step 2. The Type of Payoff: Continuous and Discontinuous 41

Step 3. Barriers 43

Step 4. Dimension of the Structure and the Number of Assets 43

Step 5. Order of the Options 45

Step 6. Path Dependence 46

3 Market Making and Market Using 48

Book Runners versus Price Takers 48

 Commoditized and Nonstandard Products 50

Trading Risks in Commoditized Products 51

Profitability 53

Proprietary Departments 54

Tacit Rules in Market Making 56

Market Making and the Price for Immediacy 57

Market Making and Autocorrelation of Price Changes 58

Market Making and the Illusion of Profitability 58

Adverse Selection, Signaling, and the Risk Management of

Market Makers 60

Value Trading versus the Greater Fool Theory 62

Monkeys on a Typewriter 64

The Statistical Value of Track Records 64

More Modern Methods of Monitoring Traders 65

The Fair Dice and the Dubins-Savage Optimal Strategy 65

The ArcSine Law of the P/L 66

4 Liquidity and Liquidity Holes 68

Liquidity 68

Liquidity Holes 69

Liquidity and Risk Management 70

 Stop Orders and the Path of Illiquidity 70

Barrier Options and the Liquidity Vacuum 72

One-Way Liquidity Traps 73

Holes, Black-Scholes, and the Ills of Memory 73

Limits and Market Failures 74

Reverse Slippage 74

Liquidity and Triple Witching Hour 75

Portfolio Insurance 75

Liquidity and Option Pricing 77

5 Arbitrage and the Arbitrageurs 80

A Trader's Definition 80

Mechanical versus Behavioral Stability 81

The Deterministic Relationships 82

Passive Arbitrage 83

An Absorbing Barrier Called the "Squeeze" 84

Duration of the Arbitrage 84

Arbitrage and the Accounting Systems 85

Other Nonmarket Forms of Arbitrage 86

Arbitrage and the Variance of Returns 87

6 Volatility and Correlation 88

 Calculating Historical Volatility and Correlation 92

Centering around the Mean 92

Introducing Filtering 95

There Is No Such Thing as Constant Volatility and Correlation 97

The Parkinson Number and the Variance Ratio Method 101

PART II

MEASURING OPTION RISKS

The Real World and the Black-Scholes-Merton Assumptions 109

Black-Scholes-Merton as an Almost Nonparametric Pricing System

109

7 Adapting Black-Scholes-Merton: The Delta 115

Characteristics of a Delta 116

The Continuous Time Delta Is Not Always a Hedge Ratio 116

Delta as a Measure for Risk 121

Confusion: Delta by the Cash or by the Forward 123

Delta for Linear Instruments 123

Delta for a Forward 123

Delta for a Forward-Forward 125

Delta for a Future 125

Delta and the Barrier Options 126

 Delta and the Bucketing 127

Delta in the Value at Risk 127

Delta, Volatility, and Extreme Volatility 127

8 Gamma and Shadow Gamma 132

Simple Gamma 132

Gamma Imperfections for a Book 133

Correction for the Gamma of the Back Month 136

First Adjustment 137

Second Adjustment 138

Shadow Gamma 138

Shadow Gamma and the Skew 142

GARCH Gamma 142

Advanced Shadow Gamma 142

Case Study in Shadow Gamma: The Syldavian Elections 145

9 Vega and the Volatility Surface 147

Vega and Modified Vega 147

Vega and the Gamma 149

The Modified Vega 150

How to Compute the Simple Weightings 151

Advanced Method: The Covariance Bucket Vega 153

 Forward Implied Volatilities 154

Computing Forward Implied Volatility 154

Multifactor Vega 158

Volatility Surface 164

The Method of Squares for Risk Management 164

10 Theta and Minor Greeks 167

Theta and the Modified Theta 167

Modifying the Theta 167

Theta for a Bet 169

Theta, Interest Carry, and Self-Financing Strategies 169

Shadow Theta 170

Weakness of the Theta Measure 171

Minor Greeks 171

Rho, Modified Rho 171

Omega (Option Duration) 174

Alpha 178

Table of Greeks 181

Stealth and Health 182

Convexity, Modified Convexity 183

The "Double Bubble" 190

11 The Greeks and Their Behavior 191

The Bleed: Gamma and Delta Bleed (Holding Volatility Constant)

191

Bleed with Changes in Volatility 195

Going into the Expiration of a Vanilla Option 196

Ddeltadvol (Stability Ratio) 200

Test 1 of Stability 200

Test 2 of Stability: The Asymptotic Vega Test 201

Moments of an Option Position 202

Ignoring Higher Greeks: The Lock Delta 204

12 Fungibility, Convergence, and Stacking 208

Fungibility 208

Ranking of Fungibility 209

Fungibility and the Term Structure of Prices: The Cash-and-Carry Line

210

Fungibility and Option Arbitrage 212

Changes in the Rules of the Game 212

Convergence 213

Mapping Convergence 215

Convergence and Convexity 216

 Levels of Convergence Trading 216

Volatility and Convergence 216

Convergence and Biased Assets 216

Stacking Techniques 217

Other Stacking Applications 220

13 Some Wrinkles of Option Markets 222

Expiration Pin Risks 222

Sticky Strikes 223

Market Barriers 224

A Currency Band: Is It a Barrier? 225

The Absent Barrier 226

What Flat Means 226

Primary and Secondary Exposures 228

14 Bucketing and Topography 229

Static Straight Bucketing 229

American and Path-Dependent Options 231

Advanced Topic: The Forward or "Forward-Forward" Bucket 231

Topography 232

Strike Topography (or Static Topography) 233

Dynamic Topography (Local Volatility Exposure) 235

 Barrier Payoff Topography 237

15 Beware the Distribution 238

The Tails 238

Random Volatility 238

Histograms from the Markets 242

The Skew and Biased Assets 245

Biased Assets 248

Nonparallel Accounting 249

Value Linked to Price 250

Currencies as Assets 250

Reverse Assets 251

Volatility Regimes 251

Correlation between Interest Rates and Carry 252

More Advanced Put-Call Parity Rules 252

16 Option Trading Concepts 256

Initiation to Volatility Trading: Vega versus Gamma 260

Soft versus Hard Deltas 262

Volatility Betting 263

Higher Moment Bets 264

Case Study: Path Dependence of a Regular Option 265

 Simple Case Study: The "Worst Case" Scenario 270

PART III

TRADING AND HEDGING EXOTIC

OPTIONS

17 Binary Options: European Style 273

European Binary Options 273

Hedging with a Vanilla 275

Definition of the Bet: Forward and Spot Bets 278

Pricing with the Skew 279

A Formal Pricing on the Skew 281

The Skew Paradox 282

Difference between the Binary and the Delta: The Delta Paradox
Revisited 284

First Hedging Consequences 286

The Delta Is a Dirac Delta 286

Gamma for a Bet 287

Conclusion: Statistical Trading versus Dynamic Hedging 289

Case Study in Binary Packages-Contingent Premium Options 290

Recommended Use: Potential Devaluations 291

Case Study: The Betspreads 292

 Advanced Case Study: Multiasset Bets 294

18 Binary Options: American Style 295

American Single Binary Options 295

Hedging an American Binary: Fooled by the Greeks 298

Case Study: National Vega Bank 298

The Ravages of Time 299

Understanding the Vega Convexity 303

Trading Methods 305

Case Study: At-Settlement American Binary Options 306

Other Greeks 307

American Double Binary Options 307

Vegas of the Double Binary 308

Other Applications of American Barriers 309

Credit Risk 311

19 Barrier Options (I) 312

Barrier Options (Regular) 312

Knock-Out Options 312

Knock-In Options 317

Effects of Volatility 319

Adding the Drift: Complexity of the Forward Line 321

 Risk Reversals 323

Put/Call Symmetry and the Hedging of Barrier Options 323

Barrier Decomposition under Skew Environments 331

The Reflection Principle 335

Girsanov 339

Effect of Time on Knock-Out Options 339

First Exit Time and Its Risk-Neutral Expectation 340

Issues in Pricing Barrier Options 343

The Single Volatility Fudge 343

A More Accurate Method: The Dupire-Derman-Kani Technique 344

Additional Pricing Complexity: The Variance Ratios 345

Exercise: Adding the Puts 346

20 Barrier Options (II) 347

Reverse Barrier Options 347

Reverse Knock-Out Options 347

Case Study: The Knock-Out Box 348

Hedging Reverse Knock-Outs: A Graphical Case Study 356

Double Barrier Options 362

Rebate 363

Exercise: Adding the Knock-In 363

 Alternative Barrier Options 363

The Exploding Option 364

Capped Index Option 365

Reading a Risk Management Report 368

Gaps and Gap Reports 374

21 Compound, Choosers, and Higher Order Options 376

Vega Convexity: The Costs of Dynamic Hedging 378

Uses of Compound Options: Hedging Barrier Vega 379

Chooser Options 380

A Few Applications of the Higher Order Options 382

22 Multiasset Options 383

Choice between Assets: Rainbow Options 384

Correlated and Uncorrelated Greeks 387

Linear Combinations 390

Basket Options 391

Lognormality 391

Correlation Issues 392

Composite Underlying Securities 395

Quantitative Case Study: Indexed Notes 395

Background 396
 Terms of the Note 396

Where Is the Underlying? 397

Triangular Decomposition 398

23 Minor Exotics: Lookback and Asian Options 403

Lookback and Ladder Options 403

The Rollover Option 404

A Footnote on Basket Options: Asian Options 408

PART IV

MODULES

Module A Brownian Motion on a Spreadsheet, a Tutorial 415

The Classical One-Asset Random Walk 415

Some Questions 417

A Two-Asset Random Walk: An Introduction to the Effects of

Correlation 420

Extension: A Three-Asset Random Walk 424

Module B Risk Neutrality Explained 426

Step 1. Probabilistic Fairness, the "Fair Dice" and the Skew 426

Step 2. Adding the Real World: The Risk-Neutral Argument 427

The Drift 427

Module C Numeraire Relativity and the Two-Country Paradox 431

Another random document with
no related content on Scribd:
holding Uganda. These results have followed very rapidly the
political partition of the continent.
The final blow has been given by the act of the Brussels
Antislavery Conference, lately ratified by the powers, wherein
modern civilization has fully declared its opinions upon the question
of slavery, and no single power will dare remain indifferent to them,
under penalty of obloquy and shame.
The first article of the Brussels act is as follows:
“The powers declare that the most effective means for
counteracting the slave trade in the interior of Africa are the
following:
“1. Progressive organization of the administration; judicial,
religious, and military services in the African territories placed
under the sovereignty or protectorate of civilized nations.
“2. The gradual establishment in the interior by the
responsible power in each territory of strongly occupied
stations in such a way as to make their protective or
repressive action effectively felt in the territories devastated
by man-hunters.
“3. The construction of roads, and, in particular, of railways
connecting the advanced stations with the coast, and
presenting easy access to the inland waters and to the upper
reaches of streams and rivers which are broken by rapids and
cataracts, so as to substitute economical and speedy means
of transport for the present means of portage by men.
“4. Establishment of steamboats on the inland navigable
waters and on the lakes, supported by fortified posts
established on the banks.
“5. Establishment of telegraphic lines, assuring the
communication of the posts and stations with the coast and
with administrative centres.
“6. Organization of expeditious and flying columns to keep
up the communication of the stations with each other and with
 the coast, to support repressive action, and to assume the
security of roadways.
“7. Restriction of the importation of fire-arms.”
The above articles concern three powers especially, Great Britain,
Germany, and the Congo State, so far as regards the efficient
counteraction of the slave trade. In examining them one by one, we
find that Great Britain, which in the past was foremost in the cause of
the slave, has done and is doing least to carry out the measures
suggested by the great Antislavery Conference. We must also admit
that as regards furthering the good cause, France is a long way
ahead of England.
The Congo State devotes her annual subsidies of £120,000 and
the export tax of £30,000 wholly to the task of securing her territory
against the malign influences of the slave trade, and elevating it to
the rank of self-protecting states.
The German government undertakes the sure guardianship of its
vast African territory as an imperial possession, so as to render it
inaccessible to the slave-hunter, and free from the terrors, the
disturbances, the internecinal wars, and the distractions arising from
the presence or visits of slavers. It has spent already large sums of
money, and finds no difficulty in obtaining from Parliament the sums
requisite for the defence and the thorough control and management
of the territory as a colonial possession. So far the expenses, I think,
have averaged over £100,000 annually.
The French government devotes £60,000 annually for the
protection and administration of its Gaboon and Congo territory.
These two objects include in brief all that the Antislavery Conference
deemed necessary, for with due protection and efficient
administration there can be no room for slave hunting or trading.
Now the question comes, what has England done in the extensive
and valuable territory in East Africa which fell to her share as per
Anglo-German agreement signed July 1, 1890? The answer must be
that she has done less than the least of all those concerned in the
extirpation of the slave trade.
 The Germans have crushed the slave-traders, have built fortified
stations in the interior, have supplied their portion of the east coast
with a powerful flotilla of steamers, are engaged in transporting
cruisers to the three great lakes on their borders, have surveyed and
are extending surveys for several railways in the interior, have not
lost time in discovering ways of evading the territorial wants, but
have set about to supply these wants as indicated by the
International Conference of Brussels; and were we able to obtain an
instantaneous photograph of the present movements of the
Germans throughout their territory, we should know how to fully
appreciate the hearty spirit with which they are performing their
duties.
And were we able to glance in the same way as to what is
occurring on British soil, we should be struck by the earnestness of
the Germans as compared with the British.
 AN ARAB
Both governments started with delegating their authority to
chartered companies. On the part of the Germans, however, the
imprudence of their agents imperilled their possessions, and the
imperial government set itself the task of reducing malcontentism to
order, and settling the difficulties in its own masterful manner, and is
engaged in providing against their recurrence before surrendering
the territory again to the influences of the company.
 The British East African Company, on the other hand, has been
comparatively free to commence its commercial operations,
undisturbed by armed opposition of aborigines or of Arab and
Swahili residents. The welcome given to it has been almost
universally cordial. The susceptibilities of the Arabs were not
wounded, and the aborigines gratefully recognized that the new-
comers were not hostile to them. Concessions were obtained at a
fair price, and on payment of the stipulated value the company
entered into possession, and became, with the consent of all
concerned, masters of the British East African territory—a territory
far more ample than what the founders of the company had hoped
for at first.
Had the British East African Company confined its transactions
and operations to the coast, it is well known that the returns would
have been most lucrative, for over and above the expenditure we
see by their reports that there would have been a yearly net gain of
over £6000 available for dividend, which by this time would have
been trebled.
But the Berlin Conference of 1884-5 expressly stipulated (Article
VI.) that all powers exercising sovereign rights or having influence in
the said territories (shall) undertake to watch over the preservation of
the native races and the amelioration of the moral and material
conditions of their existence, and to co-operate in the suppression of
slavery, and, above all, of the slave trade; (that) they will protect and
encourage all institutions and enterprises, religions, etc., re-
established or organized, which tend to educate the natives; and in
Article XXXV. it is stipulated that the power which in future takes
possession of a territory, or assumes a protectorate, recognizes the
obligation to insure in the territories occupied by it on the coasts of
the African continent the existence of an adequate authority to
enforce respect for acquired rights.
Therefore the back-land of British East Africa could not remain the
theatre of slave raids, or unclaimed.
It devolved upon the occupants of the sea-frontage to exercise
their sovereign rights, and in the due exercise of these to watch over
the native races of the back-lands, and to co-operate for the
suppression of slavery and the slave trade. It was incumbent upon
them also to protect and encourage the Christian missions, without
distinction of nationality or creed, which were established in Uganda
—the most important because most populous and most promising of
these back-lands. And to insure its acquired right to those countries it
was necessary that the British company should be represented by
adequate authority there, otherwise it would be in the power of any
person, society, or power to bar its claim to them by actual
occupation.
Following the declarations of the powers at the Berlin Conference
in 1885 is the act of assembled civilization at Brussels in 1890,
emphasizing and reiterating the conditions upon which sovereignty
shall be recognized. They point out in detail what ought, what indeed
must be done. They say that the responsible power ought—which is
almost equivalent to must in this case—to organize administration,
justice, and the religious and the military services, to establish
strongly occupied stations, to make roads, particularly railroads, for
the sake of easy access to the inland waters, to inaugurate steamer
service on the lakes, erect telegraphic lines, and restrict the
importation of fire-arms.
The British East African Company as a commercial company is
unable with its own means to meet these conditions. What it can it
will, and its ability is limited to a sacrifice of all the dividends
available from its commercial operations on the coast for the benefit
of the whole territory, and subscribing a few more thousands of
pounds to postpone retreat. Yet as the delegate of the British
government the company is bound not to neglect the interior. It is
pledged to insure the protection of British subjects in Uganda, to
protect the Waganda from internecine and factional wars, to place
steamers on Lake Victoria for the protection of the lake coasts, and
to prevent the wholesale importation of fire-arms. But in the attempt
to do what Europe expects to be done the company has been
involved in an expense which has been disastrous to its interests. It
has established adequate authority in Uganda, but the maintenance
of the communication between Uganda and the coast is absolutely
ruinous. It has to pay £300, or thereabouts, the ton for freight. Thus,
to send 150,000 rounds of ammunition, which is equal to twelve
tons, costs £3600. To send the cloth currency required for purchase
of native provisions for the force costs £12,000. Add the cost of
conveyance of miscellaneous baggage, European provisions and
medicines, tools, utensils, tents, besides the first cost of these
articles and the pay of the men, and we at once see that £40,000 per
annum is but a small estimate of the expense thus entailed upon the
company. Meantime the transportation of steamers to Lake Victoria,
the erection of stations connecting the lake with the sea, and many
other equally pressing duties, are utterly out of the question. The
directors understand too well what is needed, but they are helpless.
We must accept the will for the deed.
This much, however, is clear: Europe will not hold the British East
African Company, but England, responsible for not suppressing the
slave trade and slave hunt. The agreement with Europe was not
made by the company, but by Great Britain through her official and
duly appointed representatives. When her official representatives
signed the act of the Brussels Antislavery Conference, they
undertook in the name of Great Britain the important responsibilities
and duties specified within the act. The representatives of all Europe
and the United States were witnesses to the signing of the act. To
repudiate the obligations so publicly entered into would be too
shameful, and if the majority in Parliament represents the will of the
people there is every reason to think that the railway to the Victoria
Nyanza, which is necessary for carrying into effect the suggestions
of the Antislavery Conference, will be constructed.
I have been often asked what trade will be benefited by this
railway to the Nyanza, or what can be obtained from the interior of
Africa to compensate for the expense—say £2,000,000—of building
the railway. There is no necessity for me to refer to the commercial
aspect of the question in such an article as this, but there are some
compensating advantages specially relating to my subject-matter
which may be mentioned.
First. England will prove to Europe and the world that she is
second to no other power in the fulfilment of her obligations, moral or
material.
Second. She will prove that she does not mean to be excelled by
Germany, France, or Belgium in the suppression of the slave trade
and the man hunt, nor is averse to do justice to the Africans whom
she has taken under her wing.
Third. She will prove that the people on British territory shall not be
the last to enjoy the mercies and privileges conceded to the negroes
by civilization, that the preservation of the native races and their
moral and material welfare are as dear to England as to any other
power, that the lives of her missionaries shall not be sacrificed in
vain, that the labors of her explorers are duly appreciated, that she is
not deaf to the voices of her greatest and best, and, in brief—to use
the words uttered lately by one of her ministers—she will prove that
“her vaunted philanthropy is not a sham, and her professed love of
humanity not mere hypocrisy.”
The objective point for the British East African Company, for the
people and government of Great Britain, is the Victoria Nyanza, with
1400 miles of coast-line. So far as the British as a slavery-hating
nation are concerned, their duties are simply shifted from the ocean
coast to the Nyanza coast, 500 miles inland. The slave-trader has
disappeared from the east coast almost entirely, and is to be found
now on the lake coasts of the Victoria, or within British territory. The
ocean cruiser can follow him no farther; but the lake cruiser must not
only debar the guilty slave-dhow from the privilege of floating on the
principal fountain of the Nile, but she must assist to restrict the
importation of fire-arms from German territory, from the byways of
Arab traffic, from the unguarded west; she must prevent the flight of
fugitives and rebels and offenders from British territory; she must
protect the missionaries and British subjects in their peaceful
passage to and fro across the lake; she must teach the millions on
the lake shores that the white ensign waving from her masthead is a
guarantee of freedom, life, and peace.
To make these great benefits possible, the Victorian lake must be
connected with the Indian Ocean by a railway. That narrow iron track
will command effectively 150,000 square miles of British territory. It is
the one remedy for the present disgraceful condition of British East
Africa. It will enable the company to devote the thousands now spent
wastefully upon porterage to stimulating legitimate traffic, and to
employ its immense caravans in more remunerative work than
starving and perishing on British soil; to grace the surroundings of its
many stations with cornfields and gardens; to promote life, interest,
and intellect, instead of being stupefied by increasing loss of brave
men and honest money. It will create trade in the natural productions
of the land, instead of letting Arabs traffic in the producers. Clarkson
long ago said that legitimate trade would kill the slave traffic; Buxton
repeated it. Wherever honest trade has been instituted and fairly
tried, as in the southern part of the United States, in Jamaica and
Brazil, as in Sierra Leone and Lagos, in Old Calabar, in Egypt and
the lower Congo, always and everywhere it has been proved that
lawful commerce is a great blessing to a land by the peace it brings,
by its power of creating scores of little channels for thrifty industry, by
the force of attraction it possesses to draw the marketable products
into the general mart. And this is what will surely happen upon the
completion of the Victoria Nyanza Railway, for the slave trade and
slavery will then be rendered impossible in British African territory.

THE END
 Transcriber’s Notes
Page 37: “peformed this feat of strength” changed to “performed this feat of strength”
Page 38: “undertaken to peform” changed to “undertaken to perform”
Page 76: “over and above the expediture” changed to “over and above the expenditure”
*** END OF THE PROJECT GUTENBERG EBOOK SLAVERY AND
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