The article title implies that those strategies are almost free money. And then there is no mentioning of risks at all. ZERO. Anyone who was reading the article could see this coming. The writing was on the wall.

But the really scary part came about two weeks later.

Catastrophic Loss Event

On November 15, 2018, OptionSellers.com notified its investors in an email entitled “Catastrophic Loss Event” that it not only lost all their money, but that they would also owe money to Intl FC Stone for margin calls. According to OptionSellers.com, they lost a substantial portion of their investors’ assets due to a short call position in natural gas that, according to Optionsellers.com “was so fast and intense that it overwhelmed all risk measures in place.”

It then informed investors that they have a debit balance in their accounts which they need to bring back to zero by paying INTL FC Stone the difference. So, in addition to trying to process the news all their money is gone, they also have INTL FC Stone breathing down their necks demanding they pay the money they owe for its margin calls.

According to Investors Watchdog,Tampa-based OptionsSellers.com touts itself as premier and highly experienced commodities options trading firm. The firm’s president and head trader, James Cordier, explained in a recent interview: “Our goal is to take an aggressive vehicle and manage it conservatively.”

Unfortunately, it did not trade options conservatively. It traded “naked” rather than “covered” options, leaving investors subject to unlimited exposure. This unlimited exposure is what caused to lose all their money and more in the last few days. Thus, OptionSellers.com and its principals negligently engaged in a risky trading strategy that was unsuitable for its clients and breached its fiduciary duties to them by putting its interests ahead of its clients.

What Happened?

This is a pretty good explanation from Palisade Research:

 

He blew himself up by selling naked call options on Natural Gas. . .


Mr. Cordier with his expert financial opinion thought it was wise to sell naked call options on Natural Gas.

The thesis was that the 2018 winter was expected warmer than previously thought. And with the over-supplies of Nat Gas coming in from higher prices – Nat Gas would weaken over the next few months.
 

So Mr. Cordier made a bearish bet on Nat Gas by writing naked call options.


Remember – a naked call option is when a speculator writes (sells) a call option on a security without ownership of that security. It is one of the riskiest options strategies because it carries unlimited risk. . .

 

He thought that he could take advantage of the ‘peak’ natural gas price two ways.
 

First – since Nat Gas prices were up recently, he could sell options for higher premiums as bullish investors came in. Giving him more upfront profits.


And Second – he believed that Nat Gas prices peaked. And would soon turn south. Which meant the options he sold would expire – and he would be off the hook.


And at the very least – he didn’t think Nat Gas prices were set to go that much higher.


But they did. . .


Nat Gas shot up nearly 20% in a single afternoon last week – to its highest price since 2014. Some say that the added buying sparked a ‘short-squeeze’ – when a heavily shorted stock or commodity moves sharply higher, forcing more short sellers to close out their short positions.

 

 

Soon after the smoke cleared he had to break the news to investors and clients.


He sent a letter – and made a video apology (you can watch it below) – telling everyone about the unfortunate “catastrophic” situation.

 

 

The Lessons

James Cordier is obviously not the first money manager who blew up his clients accounts (or experienced catastrophic losses). Victor Niederhoffer, Karen Supertrader, LJM Preservation And Growth Fund.. there are probably many others less famous.

Naked options by themselves are not necessarily a bad thing. The problem is leverage and position sizing. If implemented correctly, naked options can make money in the long term. But if you overleverage, you just cannot recover from the inevitable occasional losses. We warned our readers about the dangers of naked options and leverage on several occasions.

As our contributor Jesse Blom mentioned:

 

All 3 of these examples, and the newest one, share the common element of leverage. Excessive leverage, and also lack of diversification. Strategies like naked option selling work fine if you ignore margin requirement and view risk based on notional exposure. Parametric’s VRP paper shows how a SPX naked strangle has been less risky than owning the underlying index when sized based on notional exposure. For example, that means selling 1 SPX strangle per ~$265,000 of capital today.

But in this case, James Cordier took commodity futures (NG) which is itself a leveraged instrument, and applied even more leverage using naked options. Here are the elements that contributed to the failure:

  • Using highly leveraged instrument like Natural Gas futures.
  • Writing naked options that have theoretically unlimited risk.
  • Using leverage on already leveraged instrument.
  • Using no hedging or risk management.
     

The result was disastrous and inevitable. It always is when someone is using extreme leverage like this one.

As one of our members wrote: “People see these crazy returns and think these personalities are doing something magical when really most are just levered to the hilt and taking dumb risk when there are several reasonable ways to hedge”.
 

One macro hedge fund founder faulted both Cordier and his investors for the outcome. “The nature of the strategy is that you make a little bit of money until you blow up. The probability of losing it all is fairly significant. With derivative contracts — if you don’t understand them — you really need to give money to someone you trust, and to couple of them. Have some checks and balances.” OptionSellers.com “basically took advantage of guys who didn’t know any better. I instantly thought of my grandmother, my grandfather. I honestly was thrown when I heard about it.”  

Conclusion

To add insult on injury, it turns out that James Cordier enrolled his clients into managed accounts and not a fund. This was the reason why his clients not only have lost all their money, but that they also owe money to their broker for margin calls. 

Should we feel sorry for the Mr. Cordier? There is no sympathy from Josh Brown, the Reformed Broker:
 

Some people made me aware of how he was marketing this fund. He called it a retirement strategy. It’s not a retirement strategy, it’s speculation. I don’t feel bad for James Cordier, or his “clients.” Taking in premiums from selling calls – picking up nickels – and having no idea of the potential for a blow-up is the most childish thing I’ve ever heard. No, the laws of risk and reward are not repealed just because someone sounds sophisticated when discussing derivatives. Risk cannot be eliminated, only transformed. This man sold investors a lie. And now he compounds it with a new lie – “a rogue wave came along and capsized us!” GMAFB.

Google this guy’s sales pitch when you get a chance.

If your strategy bets on the movement of commodities and it isn’t durable enough to survive the movement of commodities, perhaps you have no business managing money in the first place. So no, no sympathy. Fuck you and your cufflinks too.
 

“The problem with experts is that they do not know what they do not know.” 

― Nassim Nicholas Taleb.

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