Why Did Optionsellers.com Go Bust? What Happened with OptionSellers.com?
Everyone’s been talking about optionsellers.com, the hedge fund that lost a staggering $150+ million dollars of clients’ money by being short calls on natural gas.
They sold options and went bust.
Optionsellers was a hedge fund with ~$150 million dollars in assets.
What’s interesting is that their management (and quality control / oversight) was quite small for a hedge fund.
The fund was run by James Cordier, often referred to as ‘’the options king’’, or the "king of options."
People who partake in option selling tend to sell option premium, which is an amazing strategy.
However, OptionSellers.com went bust and there are a couple of main reasons behind it.
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What Went Wrong With Optionsellers.com?
The first reason is greed. When selling option premium, you can manipulate the trades to have them be profitable 90% - 95% of the time.
However, even if you’re profitable 95% of the time, if your trading size is too large, then those 5% that go against you can result in losing a large amount of money.
This is what happened with OptionSellers.com and it's actually more common than you'd think with beginner traders.
Here’s an example:
Most of my students make money. However, in October and December of 2018, some of them lost money which they haven’t been able to recover yet (as of May 2019).
What caused this is the fact that prior to October and December of 2018, they were winning almost every one of their trades.
After winning almost all their trades, ~3% per month was no longer enough. Instead, they were trying to make ~15% a month by selling strike prices that were too close to the current market price.
Also, they were selling way too many contracts.
When their positions started going against them, they were unable to roll and manage the positions and profit from a volatility contraction. Instead, they were forced to close the positions for a loss.
By trading too large and getting greedy, a few of my students were no longer able to defend their positions.
Key Points: OptionSellers.com Mistakes
They traded too large & got greedy
OptionSellers.com became complacent and traded too many contracts. They simply got greedy, lacked discipline and got caught.
They got unlucky
Natural gas went up ~60% in ~2 weeks. This is an extremely large move that is very rare. Even so, while a ~60% move is unlikely, it happens occasionally. Had OptionSellers.com traded smaller, they actually would have made money from their position because natural gas prices collapsed quickly.
They traded commodities
Commodities are small markets (usually just a few billion dollars) and have the tendency to lack two-sided price action. As a result, they can go up (or down) ~10 days in a row regularly; this situation is more rare with stocks.
OptionSellers.com made the same mistake as a few of my students.
Since OptionSellers.com was used to winning all their trades, they got greedy and started trading too big.
Because of their greed, they were choosing strike prices that were too close to the current market price.
Plus, their their size was about 10 times larger than it should’ve been.
"OptionSellers.com got used to winning all their trades and they got greedy and weren't disciplined. As a result, they blew up." - David Jaffee, BestStockStrategy.com
Why Are Commodities Risky for Trading?
Commodities have a history of going hyperbolic. It’s not uncommon for a commodity to go up ten days in a row, or in contrast, to fall for ten days in a row.
In James Cordier's case, natural gas went up to ~60% in 1 - 2 weeks, only to collapse shortly thereafter.
When trading commodities you have to be aware that they’re inherently a lot riskier than equities.
Equities have two-sided action; there are earnings, dividends, deep markets, hedge funds, private offices, pension funds, etc. This helps to support the stock price.
However, with a commodity, even though it’s a liquid market, it’s still relatively small.
The natural gas market is probably not much larger than $5 - $10 billion dollars, or perhaps even smaller.
As a result, volatile moves on both the upside and the downside are not uncommon.
This is exactly what happened with natural gas. During a 1 -2 week time period, it increased in price by ~60%.
This price action is not uncommon with commodities.
In January 2016, oil fell to about $26 per barrel and now it's trading at 2.5x that.
We saw a similar situation in mid-August of 2018 when gold fell to around $1,100. This year, in early February of 2019, gold traded above $1,300.
We can safely conclude that commodities are extremely volatile. That’s one of the reasons why I avoid trading them.
Occasionally, I do trade a small amount of gold because it’s uncorrelated with the overall S&P 500. But even when I do trade gold, I trade options on the GLD or the GDX, not the actual commodity itself in the futures market.
What Can You Do to Avoid the Mistakes that OptionSellers made?
When trading gold, I tend to take a very small position.
One of the reasons OptionSellers.com got burned is because they traded commodities which have a history of being volatile.
Also, they simply got unlucky.
When trading commodities, there is a higher possibility of getting unlucky. You should be aware that, even though you’re going to win 95% of your trades when you sell options, there’s still that 5% of the time that you’re going to lose when trading options and you need to learn how to control your risk.
You have to plan accordingly and avoid trading too many contracts.
OptionSellers.com would still be open if they traded 10% as many contracts as they did.
Actually, not only would they still be open, but their original position would have made them money.
After OptionSellers.com collapsed, the price of natural gas fell.
But Option Sellers traded about 10x as many contracts as they should have traded, and they paid the price by losing their hedge fund.
Bad luck definitely played a part. Natural gas is probably not going to experience a move of that magnitude during the next few years. It just so happened that optionsellers.com was on the wrong side of the market. They were overexposed which caused the destruction of their hedge fund.
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Why Do Retail Traders Sell Option Premium?
Retail traders don’t have a choice.
If they want to make consistent profits in the stock market then they need to learn how to sell option premium.
The only alternative would be to hold an SPY index and earn about 4-5% per year.
If you're interested in learning how to sell options premium then you can learn more about it here.
Day trading doesn't work. There was a study that looked at 360,000 day traders. The study analyzed every single trade they made and 359,000 were consistently losing money. The top 500 out of the original 360,000 earned just 5% alpha.
That means that, if an individual just held the SPY ETF index, they would have beaten close to 99.9% of day traders!
You need to learn how to sell option premium if you want to be profitable.
But... unlike OptionSellers.com, you need to be disciplined!
Conclusion: OptionSellers Hedge Fund
You don’t have a choice if you’re looking to achieve alpha and achieve outsize gains in the stock market. You have to sell option premium.
If you decide to do so, learn from James Cordier’s mistakes. Remember to NOT get greedy and, if you choose to trade commodities, trade them very small.
Learn from the best traders and teacher, take our online courses to improve your knowledge and experience.
What happened to optionsellers.com is not common, however. It’s just a perfect confluence of multiple factors that led them to bankruptcy.
That’s what happens when you get careless and greedy.