Why Did Optionsellers Blow Up? 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 shorting commodities (natural gas calls).
Optionsellers sold options and blew up.
Optionsellers was a hedge fund with ~$150 million dollars in assets.
What’s interesting is that their management (and quality control / oversight) was ineffective for a hedge fund.
The fund was run by James Cordier, often referred to as ‘’the options king’’, or the "king of options."
Professional traders who trade options tend to engage in option selling, which is an amazing strategy.
However, OptionSellers.com blew up and we'll discuss the primary reasons below:
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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 (or if you're not hedged), then those 5% that go against you can result in losing a large amount of money because you'll run out of buying power and be forced to close all your positions at the worst time (correlation risk).
This is what happened with OptionSellers.com and it's actually more common than you'd think (especially with beginner traders).
It's common for option sellers to win ~98% of their trades, however during large volatility expansion events like March 2020, it's possible to get placed in a margin call and be forced to close positions for a large loss if you're trading too large.
People tend to become overconfident when they're winning all their trades and they begin to think of option selling as "easy money".
After winning almost all their trades, ~3% per month is no longer enough. Instead, traders take on more risk and try to earn ~15% a month by selling strike prices that are too close to the current market price and / or they sell too many contracts.
When their positions start going against them, they are unable to roll and manage the positions and profit from a volatility contraction or price stabilization because they're forced into a margin call and have to close their positions.
By trading too large and getting greedy, many people were no longer able to defend their options positions in March 2020, and they suffered big losses.
Key Points: OptionSellers.com Mistakes
1
They traded too large & got greedy
OptionSellers.com became complacent and traded too many contracts. They simply got greedy, lacked discipline and got caught.
2
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.
3
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 made the same mistakes as many beginner option traders.
Since OptionSellers.com was used to winning all their trades, they got greedy and started trading too big.
Because of their greed, they chose strike prices that were too close to the current market price.
Plus, their their size was about 10x larger than it should’ve been.
Optionsellers.com also failed to hedge their positions.
"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
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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 it's important 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 (as mentioned before, the price of natural gas went up ~60% within 1 - 2 weeks).
This type of price action is not uncommon with commodities.
In January 2016, oil fell to about $26 per barrel and now it's trading at ~3x that (yet oil prices have traded below $0 (NEGATIVE OIL PRICE) multiple times over the past few years).
We saw a similar situation in mid-August of 2018 when gold fell to around $1,100.
In 2023, gold trades above $1,900.
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, I don't trade the commodity via 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 (imagine being right yet losing everything because you couldn't stay in the trade!).
Option Sellers traded about 10x as many contracts as they should have traded, and they paid the price by blowing up their hedge fund.
They also failed to pro actively hedge their positions (something I teach in the option trading education course).
Bad luck definitely played a part. Natural gas is probably not going to experience a move of that magnitude in the near future . It just so happened that optionsellers.com was on the wrong side of the market.
It was the perfect storm of factors that caused them to blow up.
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Why Do Retail Traders Sell Option Premium?
Retail traders don’t have a choice but to sell option premium (or simply go long an index fund).
If retail traders 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 a market index (such as SPY) and earn about 6% 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: Why Did OptionSellers Hedge Fund Blow Up?
You don’t have a choice if you’re looking to achieve alpha and realize significant gains in the stock market - you have to sell option premium (while pro actively hedging your portfolio).
If you decide to trade options, 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.
Frequently Asked Questions (FAQs)
How much money did James Cordier lose?
The hedge fund lost around $150 million of their clients' money in a matter of days after natural gas increased in price by ~60%.
How did James Cordier lose money?
Cordier bet that natural gas prices would go down while crude oil prices went up. The reverse happened, and just like that, his clients lost at least $150 million. "Needless to say, the events of this past week have been incredibly devastating,'' Cordier said in a flat-voice apology on YouTube.
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