OptionSellers.com was a hedge fund that up until November 16, 2018, served 280 high-end investors. On that fateful autumn day, CEO and Hedge Fund Manager, James Cordier, sent an email and video apology to all OptionSellers investors.
It was his job to inform them that the OptionSellers hedge fund was gone, kaput, along with more than 100% of client investments. Not only did investors lose about $150 million in assets, but they also owed the brokerage account above and beyond their already horrific losses.
So how does a hedge fund manager lose more than 100% of investor funds? By not hedging the trade at all. What OptionSellers was promoting was a risk so extreme, even the fund manager himself warned against it in a blog post some years back.
What happened to the OptionSellers’ hedge fund?
Mr. Cordier made a high risk “naked” call option. Now a call option is essentially an option to purchase assets at an agreed upon price either on a specific date or before it. The naked part means there is no security behind the trade. So, no ownership of the asset, no hedging the risk. Options without proper risk assessment open up investors to unlimited risk if and when a market moves quickly.
What’s interesting is that this was a hedge fund. Hedge fund managers invite investors to put up big money in investment vehicles that may seem riskier but have the potential to garner higher gains. Mr. Cordier, as the experienced fund manager, made the trades on behalf of his clients. But it seems this type of investment far outstretched the bounds of hedge fund trading.
In this case, even for a hedge fund, it was an extremely risky venture. They place a naked call option on a commodity, natural gas. The thinking was that it was peak pricing for natural gas at the time. Prices had gone up recently, so he would have been able conceivably to sell the option at a higher premium as bullish investors came on board, increasing upfront profits.
Even Mr. Cordier realized the dangers of commodities options, and cautioned readers of his blog that, “The important thing is that you have some kind of exit plan in place.” Clearly, he did not take his own advice.
The catastrophic loss event
The whole premise was based upon Mr. Cordier’s belief that natural gas prices were peaking and would soon start to go back down. In this scenario, the options he sold would hopefully expire and he would be off the hook and plum with premiums.
To better explain it, lawyers at Peiffer Wolf Carr & Kane gave this overview:
“The Catastrophic Loss Event that caused these losses is known as a “short squeeze.” Specifically, there was a “short squeeze” in natural gas and crude oil. Participants in the market “covered” short positions, causing a spike in the price of natural gas and crude oil. At this moment, OptionSellers.com had a large short call position. Thus, OptionSellers.com didn’t hedge investor assets and investors experienced a complete loss.”
Mr. Cordier certainly didn’t think natural gas prices would go much higher, but they did. And as the researchers at Palisade put it:
“He positioned himself so that his upside was capped but his downside was unlimited.”
Adding salt to the wound
It was bad enough that these investors saw 100% of their principal vanish. Some of them lost even more. Much more. The brokerage firm, INTL FCStone, issued margin calls after liquidating investor accounts held by OptionSellers clients. They found that some account balances had fallen below the minimum margin requirements due to OptionSellers’ initial attempt to damage control their ‘bad call’.
Subsequently, these clients now owe over $35 million to the brokerage firm. This is to cover the negative equity brought on by the fund’s mismanagement. That is above and beyond the complete loss of their principal.
Experts agreed – too risky
Many experienced traders and fund managers agreed that a combination of three characteristics made Cordier’s strategy so dangerous:
- Natural gas futures are a leveraged instrument, something that allows a trader to pay less than the full price for a trade. Leveraged means it enables traders to take larger positions than would be possible with their account funds alone. A naked option brought an even higher level of leverage.
- Using a naked option strategy invites unlimited risk. While it may have seemed unlikely that prices would change so quickly and drastically, the potential for catastrophe over a period of time is imminent.
- Bypassing any hedging or risk management puts everybody at extreme risk.
An apology letter, referring to the incident as a “Catastrophic Loss Event’, was sent out with an emotional video to all investors to report the loss. Meanwhile, Cordier continues to sell a best-selling options trading book he co-wrote in which he touts his options strategies. Not surprisingly, he has recently received a spate of negative book reviews warning prospective book buyers since the video went viral.
The OptionSellers fiasco is exactly the kind of situation we want to leave in the dust as we move towards a blockchain-based system of finance.