Why do options writer have better chance of earning

[jhollett 46]

On 11/17/2018 at 8:16 AM, apsoccermd said:

Apparently, dude also has some options books published.. 

 

https://www.amazon.com/Complete-Guide-Option-Selling-Options/dp/0071837620/ref=sr_1_1?s=books&ie=UTF8&qid=1542471354&sr=1-1

I have his books, never got into commodities though

[cuegis 683]

There were several other major catastrophes of the same kind, on the Comex, in Gold and silver during the 1984/85 period.

I was a comex member at that time, and clearly remember the cases being mentioned from this NY Times article of that period.

 

Basically, after the massive long term bull market in Gold and silver during the late 70's, ending with an explosive short rally blowoff top in 1981, the precious metals went into a decades long bear market.

 

Options on futures only began trading on the exchange in 1983, so this was all new, and novel stuff to the futures traders.

 

The "Westheimer Affair" was as notable as some of the others you mentioned.

Basically they just sold the "exchange limit" of 4000 calls (per seat) every month, and the market continually went down just perfectly, allowing these new options traders to amass some $50 million in just 2 short years.

 

They even got so greedy that they went out and bought 3 more seats for brother's in law, and cousins, so that they could sell 4000 calls for each membership.

 

It worked perfectly for about 2 years, until the inevitable 1 week explosion in gold from something like $250 to $500 in just a few days, causing the same situation as option sellers.

 

Except these were exchange members , with member margin requirements, which were basically nothing.

So they lost their $50 million and owed the clearing house almost as much....

 

As the story goes...they were located by the feds, at JFK airport with suitcases full of cash trying to make a clean escape from the country....

 

Here is the article from that time......

 

https://www.nytimes.com/1985/12/27/business/a-crucial-time-for-the-comex.html

[cuegis 683]

Another interesting story from an individual retail trader in 2014, also in Natural Gas.....

Same story, but some learning on this guys pert...

 

https://www.drwealth.com/how-i-blew-up-105000-in-my-trading-account/

[vasis 2]

Somebody from OptionSeller clients shared his statement for 1mln portfolio (you can even find a small number of April calls - absolutely useless). Looks like a horror movie - 

https://docs.google.com/spreadsheets/d/1-oj5UkqU0tMHrMnIEiuIYmTlxVWoU-VJqumykJ3IMUA/edit#gid=1356201715 

[cuegis 683]

23 minutes ago, vasis said:

Somebody from OptionSeller clients shared his statement for 1mln portfolio (you can even find a small number of April calls - absolutely useless). Looks like a horror movie - 

https://docs.google.com/spreadsheets/d/1-oj5UkqU0tMHrMnIEiuIYmTlxVWoU-VJqumykJ3IMUA/edit#gid=1356201715 

So he lost $868,000 on the short calls but at least he made $8000 on the short puts!

[clipsnation183 84]

1 hour ago, cuegis said:

So he lost $868,000 on the short calls but at least he made $8000 on the short puts!

I shouldn't be laughing, but that's pretty funny. 

[lrfsdad 10]

Look up amaranth advisors.  Also a victim of nat gas.  

[Jesse 315]

On 11/19/2018 at 7:00 AM, Kim said:

Niederhoffer, Karen Supertrader, LJM 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 probably make money in the long term. But if you overleverage, you just cannot recover from the inevitable occasional losses.

 

Exactly right. 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.

[cuegis 683]

59 minutes ago, Jesse said:

 

Exactly right. 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.

In addition, they were not selling naked calls on something relatively more stable.

It was Natural Gas,which is violent at the calmest of times.

And, to compound the problem, they sold naked puts on crude, and calls on Natural Gas, which typically have a degree of correlation.

But, they happened to hit on a one in a million time where the two went in extreme opposite directions, and they were naked on the wrong side of both.

That whole combination is "Black Swan-esque"

 

It just kills me when they claim that even their "strict risk control systems" that were in place, could not handle the explosive movements.

Please! They were simply short naked calls and puts, and had ZERO "risk controls" in place.

This is a market that is open,and extremely liquid, 23 hours a day, so anyone could have gotten out of this mess WAY before the catastrophe happened.

They simply just waited, and "hoped", that it would come back down and "save" them.

THAT was their "risk controls!"

 

[Kim 7,943]

 

• James Cordier: Another Options Selling Fund Goes Bust

 

[cwelsh 1,549]

A few things on this one, as this obviously held a great deal of interest to me.

 

First, how did the fund actually blow up AND have its investors subject to capital calls from the broker, that should NEVER happen.  This obviously is a major concern of mine due to the fact that we run several funds.

 

Second, how did he actually blow up from an investment standpoint.

 

The answer to the first is simply once I started looking at it, though terrifying in the level of incompetence displayed by this manager because (1) he probably didn't use an attorney in setting this all up or he could of avoided these losses or used an attorney that didn't know what they were doing and (2) that these high net worth individuals didn't know what they were doing or getting into.  Which means they weren't adequately informed/disclosed or simply didn't read the documents.  He also likely was not licensed to setup and run this as a fund structure, even if that would have been better for the investors. 

 

The media keeps referring to this as a "hedge fund."  But that is NOT what it was.  It was 290 separately managed accounts, all trading the same strategy.  It's what we did when first starting the Steady Options Fund.  Whereas a hedge fund is an actual "company," typically a limited partnership or limited liability company, that insulates investors from losing more than they invest (unless specifically structured to make investors liable, which is VERY rarely done).  Then all of the accounts are traded "in unison" with each other, also known as block trading.  On a simple level, imagine 3 accounts, each with $333,333.33 in it.  That's a total of $1m.  So when the trader goes to trade, he trades into a block account with the full $1m, then the results of those trades are distributed to each individual account.

 

The wheels started coming off here.  Since these are block accounts, that means EACH client owns their own accounts and is responsible for them.  So if he loses MORE than is available in the account, the account owner gets the bill....not the fund "manager."

 

Traditionally you can get about 16x leverage trading oil futures contracts, based on the margin requirements (though with oils recent major drop offs those margin requirements are now higher).  Using some actual older prices, this means to open a $90,000 oil and gas position, each account would have to only invest $5,610.  So if an account had $56,100 in it, he could purchase a position worth $900,000.  Then if the price of oil goes up 1% (and he's long) then his investment would go up close to 16%.

 

This is not abnormal, and exists in the normal option trading we do too.  However, that is just really, really, really poor risk management to use that much leverage.

 

For instance, in the Leveraged Anchor account, we use about 2x leverage -- AND have a "pure" hedge.  (Meaning we're long SPY and own SPY puts).  Even if the market goes to $0 (or if SPY goes to $1b per share), the accounts can't get blown out.

 

Which gets to his second mistake.  Using natural gas to hedge oil, under the theory that they move in the same direction roughly 90% of the time.  That figure actually holds pretty well, I found TEN crosses in the last 10 years. So on a daily basis, typically if oil goes up, so does natural gas.  Not at the same rates, but they normally move in the same direction.  So this guy did a basic statistical analysis and sold oil puts somewhere between 2.5 and 3.0 standard deviations out and bought on the natural gas side, also 2.5 to 3.0 standard deviations out.

 

The theory meaning that the price of EITHER wasn't likely to move over 2.5 standard deviations and if ONE did, then both were likely to do so, thereby hedging losses.

 

Only they BOTH did (to a massive amount actually) and they moved in OPPOSITE directions. So his hedge actually made his losses worse.  (E.g. not a true hedge).  I watched his video and have read a lot on this, for some reason, despite this happening on average once a year, he didn't see it as a real risk.

 

So he had on a 10x leveraged oil position and a 10x leveraged gas position.  And both prices moved over 100% on him.

 

Which gets us back to those pesky margin requirements.  Margin is NOT static.  So If I bought that $90,000 position for $5,610 of margin, when the price starts moving against me, I have to put up more margin, because the risk to the position increases.  It's not uncommon to see margin requirements double, or triple, in a very short time period.

 

Well his margin requirements went THROUGH THE ROOF.  That $100,000 account now had a margin requirement of over $100,000.  This means he's now subject to a margin call and has to either liquidate positions or put more cash up.  He did neither, which means all those accounts got forcible liquidated....but after the prices had moved even more.  

 

Now that $100,000 account has a value of -$50,000, of which the owner is responsible for putting up.  And since these are separately managed accounts, that means each separate "investor" is responsible for their share.

 

I have never taken on an options position where this could happen.  Even if there is a naked option position, which I have used at times in my life, I don't use margin to lever it up.  Let's say I'm short a 100 put on a stock worth $105.  The MOST I can lose on that trade is $10,000 (per contract), so in an account of $100,000 you'd just never sell more than 10 puts --- even if the margin requirements were only $1,000 and you could sell 10x that much.  You have then created the scenario of account blow outs.

 

These things only happen to people that don't understand risk or don't care or are idiots or are greedy idiots....or fill in your superlative here.

 

The Steady Options Fund PERFORMED poorly, but it was not poorly risk managed.  We didn't get blown out by a position, our positions just collectively lost money.  If you buy AAPL stock and the price drops 20%, you are not at risk of blowing out your account AND owing more money.  The most that can happen to you is going down to zero -- which only happens if you're 100% long AAAPL when the price goes to zero.  

 

Options, used rationally, REDUCE risk.  Used irrationally, the greatly increase it.  This guy obviously went the second route.

 

 

[cuegis 683]

1 hour ago, cwelsh said:

A few things on this one, as this obviously held a great deal of interest to me.

 

First, how did the fund actually blow up AND have its investors subject to capital calls from the broker, that should NEVER happen.  This obviously is a major concern of mine due to the fact that we run several funds.

 

Second, how did he actually blow up from an investment standpoint.

 

The answer to the first is simply once I started looking at it, though terrifying in the level of incompetence displayed by this manager because (1) he probably didn't use an attorney in setting this all up or he could of avoided these losses or used an attorney that didn't know what they were doing and (2) that these high net worth individuals didn't know what they were doing or getting into.  Which means they weren't adequately informed/disclosed or simply didn't read the documents.  He also likely was not licensed to setup and run this as a fund structure, even if that would have been better for the investors. 

 

The media keeps referring to this as a "hedge fund."  But that is NOT what it was.  It was 290 separately managed accounts, all trading the same strategy.  It's what we did when first starting the Steady Options Fund.  Whereas a hedge fund is an actual "company," typically a limited partnership or limited liability company, that insulates investors from losing more than they invest (unless specifically structured to make investors liable, which is VERY rarely done).  Then all of the accounts are traded "in unison" with each other, also known as block trading.  On a simple level, imagine 3 accounts, each with $333,333.33 in it.  That's a total of $1m.  So when the trader goes to trade, he trades into a block account with the full $1m, then the results of those trades are distributed to each individual account.

 

The wheels started coming off here.  Since these are block accounts, that means EACH client owns their own accounts and is responsible for them.  So if he loses MORE than is available in the account, the account owner gets the bill....not the fund "manager."

 

Traditionally you can get about 16x leverage trading oil futures contracts, based on the margin requirements (though with oils recent major drop offs those margin requirements are now higher).  Using some actual older prices, this means to open a $90,000 oil and gas position, each account would have to only invest $5,610.  So if an account had $56,100 in it, he could purchase a position worth $900,000.  Then if the price of oil goes up 1% (and he's long) then his investment would go up close to 16%.

 

This is not abnormal, and exists in the normal option trading we do too.  However, that is just really, really, really poor risk management to use that much leverage.

 

For instance, in the Leveraged Anchor account, we use about 2x leverage -- AND have a "pure" hedge.  (Meaning we're long SPY and own SPY puts).  Even if the market goes to $0 (or if SPY goes to $1b per share), the accounts can't get blown out.

 

Which gets to his second mistake.  Using natural gas to hedge oil, under the theory that they move in the same direction roughly 90% of the time.  That figure actually holds pretty well, I found TEN crosses in the last 10 years. So on a daily basis, typically if oil goes up, so does natural gas.  Not at the same rates, but they normally move in the same direction.  So this guy did a basic statistical analysis and sold oil puts somewhere between 2.5 and 3.0 standard deviations out and bought on the natural gas side, also 2.5 to 3.0 standard deviations out.

 

The theory meaning that the price of EITHER wasn't likely to move over 2.5 standard deviations and if ONE did, then both were likely to do so, thereby hedging losses.

 

Only they BOTH did (to a massive amount actually) and they moved in OPPOSITE directions. So his hedge actually made his losses worse.  (E.g. not a true hedge).  I watched his video and have read a lot on this, for some reason, despite this happening on average once a year, he didn't see it as a real risk.

 

So he had on a 10x leveraged oil position and a 10x leveraged gas position.  And both prices moved over 100% on him.

 

Which gets us back to those pesky margin requirements.  Margin is NOT static.  So If I bought that $90,000 position for $5,610 of margin, when the price starts moving against me, I have to put up more margin, because the risk to the position increases.  It's not uncommon to see margin requirements double, or triple, in a very short time period.

 

Well his margin requirements went THROUGH THE ROOF.  That $100,000 account now had a margin requirement of over $100,000.  This means he's now subject to a margin call and has to either liquidate positions or put more cash up.  He did neither, which means all those accounts got forcible liquidated....but after the prices had moved even more.  

 

Now that $100,000 account has a value of -$50,000, of which the owner is responsible for putting up.  And since these are separately managed accounts, that means each separate "investor" is responsible for their share.

 

I have never taken on an options position where this could happen.  Even if there is a naked option position, which I have used at times in my life, I don't use margin to lever it up.  Let's say I'm short a 100 put on a stock worth $105.  The MOST I can lose on that trade is $10,000 (per contract), so in an account of $100,000 you'd just never sell more than 10 puts --- even if the margin requirements were only $1,000 and you could sell 10x that much.  You have then created the scenario of account blow outs.

 

These things only happen to people that don't understand risk or don't care or are idiots or are greedy idiots....or fill in your superlative here.

 

The Steady Options Fund PERFORMED poorly, but it was not poorly risk managed.  We didn't get blown out by a position, our positions just collectively lost money.  If you buy AAPL stock and the price drops 20%, you are not at risk of blowing out your account AND owing more money.  The most that can happen to you is going down to zero -- which only happens if you're 100% long AAAPL when the price goes to zero.  

 

Options, used rationally, REDUCE risk.  Used irrationally, the greatly increase it.  This guy obviously went the second route.

 

 

I have also taken a special interest in this story as I had a seat on NYMEX since 1980, which was before they even had energy products.

Crude Oil futures began in 1983, and options on crude started in 1986.

There were no options on any futures contracts until 1982 when they began a "trial" experiment program in 3 commodities...Gold, Sugar, and 30 Year Bond.

They began options in crude in 1986, and I actually traded, in the new options pit, on the first day when it began..

 

Anyway, just like you, one of the things that really raises my anger level about this whole thing is that whether it is OptionSellers themselves, or the press stories, they continually keep referring to this as a "hedge fund", over and over, and nothing could be further than the truth.

 

It was exactly the structure that you described.

They were not "traders", they were exceptionally good "salesmen", who have been around this business for a long time, and even though they are totally irresponsible in their trading, they actually do understand just how it all works, and the risks involved.

 

There was NO fund, they just tried a new "sales" approach and went for the "high net worth" individuals with a $1 million account minimum, and they were ALL "individual" accounts, NO fund.

They ( the customers) signed over "power of Attorney" for these guys to have the authority to trade the "individual" accounts, which put each "individual" on the hook for 100% responsibility for anything that happened.

 

The other thing that makes my blood boil is anytime the term "risk management" is used in connection with this "operation"(?).

ZERO risk management.

They just sold naked calls and/or puts, with ZERO form of offsetting hedge position to define the risk of any position.

 

We all know the statistics on the outcome of simply selling naked options, and they actually beat those odds as they didn't blow up much sooner than they should have.

 

But, since I was even getting emails from these guys, about a year ago, I did some digging about their past and found that they had been down this road before, and there are lawsuits that you can google up, from 2011 and 2013, to see how they were sued for doing the same exact thing, with the same exact outcome, only not nearly on the level of this blow up.

 

Anyone investing $1 million should have done their due diligence, and looked up these guys names to learn about their history..

 

And, it should go without saying, that if you are investing in a so-called "hedge fund", you should fully understand just what that means....and it is NOT an individual account with power of attorney to trade handed off to someone you do not even know, leaving you with unlimited liability.

 

These guys tried this before on a smaller scale. Then as a "sales" decision, they recreated themselves in a different incarnation , going after "high net worth" individuals.

 

You would think that since they had been down this road so many times before, and had been sued, and are aware of the legal process, that they would have gotten the very best legal guidance when setting up this new business.....

 

With 290 accounts, worth $1 million minimum, they certainly had the means to have the very finest legal guidance.

 

What is going to be even more unbelievable than the story that just took place is that , after a period of time, these guys will actually come back and find another cast of innocent victims to open shop once again, with a different name,and a different target customer,and do whatever they can to hide their own names so nobody will make the association.

 

Others have done it!

 

They should have considered themselves SO fortunate to have gotten this far and beating the odds up until now.

 

All they had to do , even if they wanted to continue to be irresponsible, was to just sell call and put verticals...

At least then,they still would have cleaned up on commissions, but kept a lid on the defined risk.

 

Edited November 23, 2018 by cuegis

[cwelsh 1,549]

What also amazes me is that he is not registered (as far as I could tell on BrokerCheck) as either a broker or RIA.

 

Which means HOW THE HECK did he even get permission to trade this accounts?  I'm guessing its the same online shenanigans that you see with a lot of "advisory services" out there, but I wouldn't be surprised if there's not a coming criminal investigation to him not being properly registered.  Boggles my mind.

 

And infuriates me -- the amazing level of scrutiny we get on EVERYTHIGN (down to font sizes on pages), while a very large number of people don't even ATTEMPT to comply with the rules.  I would MUCH rather see various state securities boards to be investigating and pursuing those who refuse to play by any rules as opposed to subjecting those who do everything they can to audits and fines for not having your license hung at the right height off the floor or not having proper margin sizes on investor bills.

[SBatch 3,123]

9 minutes ago, cwelsh said:

What also amazes me is that he is not registered (as far as I could tell on BrokerCheck) as either a broker or RIA.

 

Which means HOW THE HECK did he even get permission to trade this accounts?  I'm guessing its the same online shenanigans that you see with a lot of "advisory services" out there, but I wouldn't be surprised if there's not a coming criminal investigation to him not being properly registered.  Boggles my mind.

 

And infuriates me -- the amazing level of scrutiny we get on EVERYTHIGN (down to font sizes on pages), while a very large number of people don't even ATTEMPT to comply with the rules.  I would MUCH rather see various state securities boards to be investigating and pursuing those who refuse to play by any rules as opposed to subjecting those who do everything they can to audits and fines for not having your license hung at the right height off the floor or not having proper margin sizes on investor bills.

If one only accepts Qualified Clients (a higher bar than Accredited Investors as $2 million of semi liquid assets are required) registration is not necessary, but rather simply a filed exemption.

[cuegis 683]

1 hour ago, cwelsh said:

What also amazes me is that he is not registered (as far as I could tell on BrokerCheck) as either a broker or RIA.

 

Which means HOW THE HECK did he even get permission to trade this accounts?  I'm guessing its the same online shenanigans that you see with a lot of "advisory services" out there, but I wouldn't be surprised if there's not a coming criminal investigation to him not being properly registered.  Boggles my mind.

 

And infuriates me -- the amazing level of scrutiny we get on EVERYTHIGN (down to font sizes on pages), while a very large number of people don't even ATTEMPT to comply with the rules.  I would MUCH rather see various state securities boards to be investigating and pursuing those who refuse to play by any rules as opposed to subjecting those who do everything they can to audits and fines for not having your license hung at the right height off the floor or not having proper margin sizes on investor bills.

I am pretty sure that anyone can open an account in their own name and give power of attorney to someone else to trade their account.

I might be slightly off about this as it may only apply to a limited amount of people.

I know that at IB for example, they have s structure called "Family and Friends" which operates under the umberella of an "Advisor", and is limited to 15 accounts and requires no formal regulation other than the account holder signing off permission for the "Advisor": to have power of attorney to trade each of these (15) accounts.

 

I don't what/if the rules are that change once you get above that 15 account threshold.

I don't know for a fact but, it might be possible that if you are operating a business, and start to reach numbers like 290 accounts, then some other , much more strict, form of regulations begin to apply.

 

I do know that "hedge funds" , which these guys were not, are not allowed to advertise their fund.

There is no advertising of "hedge funds".....

[SBatch 3,123]

2 minutes ago, cuegis said:

I am pretty sure that anyone can open an account in their own name and give power of attorney to someone else to trade their account.

I might be slightly off about this as it may only apply to a limited amount of people.

I know that at IB for example, they have s structure called "Family and Friends" which operates under the umberella of an "Advisor", and is limited to 15 accounts and requires no formal regulation other than the account holder signing off permission for the "Advisor": to have power of attorney to trade each of these (15) accounts.

 

I don't what/if the rules are that change once you get above that 15 account threshold.

I don't know for a fact but, it might be possible that if you are operating a business, and start to reach numbers like 290 accounts, then some other , much more strict, form of regulations begin to apply.

 

I do know that "hedge funds" , which these guys were not, are not allowed to advertise their fund.

There is no advertising of "hedge funds".....

Hedge funds can absolutely advertise if they are properly registered.

[cuegis 683]

10 minutes ago, SBatch said:

Hedge funds can absolutely advertise if they are properly registered.

I'm not doubting you but, since this story broke, in every article that I have read about it, there was some mention about hedge funds not being allowed to advertise themselves.

I had never heard anything like this before, so it seemed unusual.

But, if you know otherwise, then I will go along with what you are saying.

The whole thing did seem strange to me.

[cuegis 683]

I guess this was the part that I missed....

 

"The discussion and creation of hedge fund marketing rules is relatively new. Prior to September 2013, hedge funds were not permitted to advertise."

[cwelsh 1,549]

3 hours ago, SBatch said:

If one only accepts Qualified Clients (a higher bar than Accredited Investors as $2 million of semi liquid assets are required) registration is not necessary, but rather simply a filed exemption.

That's for a fund only -- and only under a certain number of investors NOT for separately managed accounts.

[cwelsh 1,549]

Ok, diving into hedge fund law and the highlights.

 

First, on the separately managed account item, that issues is governed by STATE law, until you have over $125m in clients (can be less, but at that level you have to federally register).  In Texas, the rule is you don't have to register until you have 5 or more clients in the state AND you don't have an office in the state AND you don't meet with the residents of Texas in Texas.  If you do that, you don't have to register. In some states, you have to register as soon as you get one client in that state.  In other states, you're exempt if you are registered in one state and have under X number of clients out there.  This is a dangerous area of the law because the rules differ state by state.  There is no conceivable scenario where this guy had over 100 clients and did not have to register.

 

To avoid registration, he COULD have set this up as a hedge fund -- meaning a legally entity -- but he did not.  Typically you do not have to register a fund under Regulation D, but you DO have to file an exemption notice.  This is a piece of paper you file through Edgar (federal registration system) claiming the exemption.  In 2013, Rule 506(c) went into effect.  If you are a Rule 506(c) fund, then you CAN advertise.  However, you can only have accredited investors and actually verify they are accredited.

 

506(b) is the old rule, under which you could have 35 unaccredited investors (but they have to be sophisticated) and unlimited accredited investors.  You do NOT have to verify the accreditor investor status, that can be self-certified (meaning the investor can just tell you they are accredited).

 

Then there are other rules on when you can charge a performance fee (typically only to qualified clients -- which are basically "super accredited investors").

 

And even if you don't have to register the fund, depending on what state you do business in, you might STILL have to register as an adviser.  For instance, in Texas, if your fund has more than five clients, the FUND does not have to be registered, but the fund MANAGER must be a licensed investment advisor.  Unless its a real estate fund, in which case different rules apply.

 

There's a reason securities lawyers make a lot of money -- the rules are messy, differ state to state and federally, and it's easy to screw things up and get in trouble.

 

However, there is no chance, running separately managed accounts, advertised online, that this guy would not have been required to register by law.  

 

Not to mention the liability possibilities with doing this all without adequate disclosures in place.  

 

 

[SBatch 3,123]

4 minutes ago, cwelsh said:

Ok, diving into hedge fund law and the highlights.

 

First, on the separately managed account item, that issues is governed by STATE law, until you have over $125m in clients (can be less, but at that level you have to federally register).  In Texas, the rule is you don't have to register until you have 5 or more clients in the state AND you don't have an office in the state AND you don't meet with the residents of Texas in Texas.  If you do that, you don't have to register. In some states, you have to register as soon as you get one client in that state.  In other states, you're exempt if you are registered in one state and have under X number of clients out there.  This is a dangerous area of the law because the rules differ state by state.  There is no conceivable scenario where this guy had over 100 clients and did not have to register.

 

To avoid registration, he COULD have set this up as a hedge fund -- meaning a legally entity -- but he did not.  Typically you do not have to register a fund under Regulation D, but you DO have to file an exemption notice.  This is a piece of paper you file through Edgar (federal registration system) claiming the exemption.  In 2013, Rule 506(c) went into effect.  If you are a Rule 506(c) fund, then you CAN advertise.  However, you can only have accredited investors and actually verify they are accredited.

 

506(b) is the old rule, under which you could have 35 unaccredited investors (but they have to be sophisticated) and unlimited accredited investors.  You do NOT have to verify the accreditor investor status, that can be self-certified (meaning the investor can just tell you they are accredited).

 

Then there are other rules on when you can charge a performance fee (typically only to qualified clients -- which are basically "super accredited investors").

 

And even if you don't have to register the fund, depending on what state you do business in, you might STILL have to register as an adviser.  For instance, in Texas, if your fund has more than five clients, the FUND does not have to be registered, but the fund MANAGER must be a licensed investment advisor.  Unless its a real estate fund, in which case different rules apply.

 

There's a reason securities lawyers make a lot of money -- the rules are messy, differ state to state and federally, and it's easy to screw things up and get in trouble.

 

However, there is no chance, running separately managed accounts, advertised online, that this guy would not have been required to register by law.  

 

Not to mention the liability possibilities with doing this all without adequate disclosures in place.  

 

 

Simply  not true, Form ADV exemption can be used for SMAs:

 

https://www.sec.gov/rules/final/2016/ia-4509.pdf

[cwelsh 1,549]

8 minutes ago, SBatch said:

Simply  not true, Form ADV exemption can be used for SMAs:

 

https://www.sec.gov/rules/final/2016/ia-4509.pdf

On Form ADV, RIAs now have to report separately managed accounts separately...but they are not exempt from registering.  Form ADV now requires you to report SMAs and the assets they hold if your an advisor.

 

The exempt reporting adviser requirement applies to (a) advisers who only advise one or more venture capital funds under 203(l) or (b) because it is an adviser solely to a private fund and has assets under $150m.  (Note this does not address state requirements if you're under $150m).  Dodd Frank actually made the private fund adviser exemption almost gone in its entirety (old rule allowed no registration for a fund that had less than 15 clients, did not advertise, and that only had accredited investors).

 

And DONT get confused the difference between having to register a fund, or a SMA, and the adviser who manages those items having to be registered -- those are two different things.  

 

I can have a non-registered fund and still be required to be registered myself if I'm the adviser to the fund.  A lot of people miss that distinction.  

[SBatch 3,123]

15 minutes ago, cwelsh said:

On Form ADV, RIAs now have to report separately managed accounts separately...but they are not exempt from registering.  Form ADV now requires you to report SMAs and the assets they hold if your an advisor.

 

The exempt reporting adviser requirement applies to (a) advisers who only advise one or more venture capital funds under 203(l) or (b) because it is an adviser solely to a private fund and has assets under $150m.  (Note this does not address state requirements if you're under $150m).  Dodd Frank actually made the private fund adviser exemption almost gone in its entirety (old rule allowed no registration for a fund that had less than 15 clients, did not advertise, and that only had accredited investors).

 

And DONT get confused the difference between having to register a fund, or a SMA, and the adviser who manages those items having to be registered -- those are two different things.  

 

I can have a non-registered fund and still be required to be registered myself if I'm the adviser to the fund.  A lot of people miss that distinction.  

 

 

15 minutes ago, cwelsh said:

On Form ADV, RIAs now have to report separately managed accounts separately...but they are not exempt from registering.  Form ADV now requires you to report SMAs and the assets they hold if your an advisor.

 

The exempt reporting adviser requirement applies to (a) advisers who only advise one or more venture capital funds under 203(l) or (b) because it is an adviser solely to a private fund and has assets under $150m.  (Note this does not address state requirements if you're under $150m).  Dodd Frank actually made the private fund adviser exemption almost gone in its entirety (old rule allowed no registration for a fund that had less than 15 clients, did not advertise, and that only had accredited investors).

 

And DONT get confused the difference between having to register a fund, or a SMA, and the adviser who manages those items having to be registered -- those are two different things.  

 

I can have a non-registered fund and still be required to be registered myself if I'm the adviser to the fund.  A lot of people miss that distinction.  

Are you stating that an exempt advisor (assets under $150 million) cannot advise a fund that has sub-accounts managed as SMAs?

[cwelsh 1,549]

52 minutes ago, SBatch said:

 

 

Are you stating that an exempt advisor (assets under $150 million) cannot advise a fund that has sub-accounts managed as SMAs?

Now you're outside of SEC rules and diving into state rules.  In Texas, South Dakota, and California, I know the answer for sure is no.  Outside of that it varies depending on your jurisdiction.

[Kim 7,943]

This whole discussion about rules and regulations is very interesting, but it is also a bit academic. The fact is that somehow this guy found a way around those rules and regulations.

And Chris, I completely agree with you - it is really frustrating to see so many people in this industry ignoring the rules, which makes a bad name for the whole industry.

Selling options is the easiest thing to do from marketing point of view. You can do it for years, and get very good results - but inevitable eventually happens. Except for many funds like Karen Supertrader, LJM fund etc. many of us still remember those trading services who went with good record for years before blowing their clients accounts (Booking Alpha, Wicked Options, Spread the Trend, Avant Options, Bullogic and many others). Since most of them are anonymous and you don't know the people behind the service, they just close and re open under a different name. Unfortunately, their clients cannot just reboot their accounts. Some of them remain open and just put on their performance page something like:

 

We all know what does it mean.

Speaking of regulations -  SEC considers newsletters that engage in auto-trading to be investment advisers. So most newsletters that engage in auto-trading are breaking the law, but somehow they get away with it for years.

Now, it has been mentioned many times that this guy hedged his oil exposure with natural gas, assuming they usually move together. However, since he used naked options, the risk/reward is not symmetrical. He sold naked calls on NG and naked puts on oil for a small premium. Even if both moved higher, he would make small gains on oil naked puts (keeping the premium), but still lose a fortune on NG naked calls. How this is a hedge is beyond me.

[garyh 1]

On 11/23/2018 at 12:48 PM, cwelsh said:

What also amazes me is that he is not registered (as far as I could tell on BrokerCheck) as either a broker or RIA.

 

Which means HOW THE HECK did he even get permission to trade this accounts?  I'm guessing its the same online shenanigans that you see with a lot of "advisory services" out there, but I wouldn't be surprised if there's not a coming criminal investigation to him not being properly registered.  Boggles my mind.

 

And infuriates me -- the amazing level of scrutiny we get on EVERYTHIGN (down to font sizes on pages), while a very large number of people don't even ATTEMPT to comply with the rules.  I would MUCH rather see various state securities boards to be investigating and pursuing those who refuse to play by any rules as opposed to subjecting those who do everything they can to audits and fines for not having your license hung at the right height off the floor or not having proper margin sizes on investor bills.

 

Since he trades futures options, he is registered with the NFA/CFTC: https://www.nfa.futures.org/basicnet/Details.aspx?entityid=nckQlikAHWE%3d&rn=Y

If only trading futures, you do not need to register with the SEC also.

 

[lrfsdad 10]

If all the proper paperwork was taken care of at account opening, I don't know how the clients can sue him.  Ive had managed futures accounts blow up and I never thought of suing anyone.  If the steady options fund goes bust can people sue?  If the stock market tanks worse than '08 can mutual fund companies be sued?  I would think risk disclosures are signed for a reason.  At least it was "accredited" investors who should know what they are getting into, not an average Joe who just lost their life savings based on a sales pitch or having everything tied up in one firm or strategy. That being said, I read that he was getting $69 commissions, what kind of accredited investor cant figure out how to sell an option on there own?

For further reading to those interested, there is a very long thread over at futures.io (formerly big mike trading) dedicated to this trading methodology.  It is quite long, but discussions regarding the blow up start here: https://futures.io/options-futures/12309-selling-options-futures-691.html#post697676 

I think you will need to register to read

[Kim 7,943]

2 hours ago, lrfsdad said:

If all the proper paperwork was taken care of at account opening, I don't know how the clients can sue him.  Ive had managed futures accounts blow up and I never thought of suing anyone.  If the steady options fund goes bust can people sue?  If the stock market tanks worse than '08 can mutual fund companies be sued?  I would think risk disclosures are signed for a reason.  At least it was "accredited" investors who should know what they are getting into, not an average Joe who just lost their life savings based on a sales pitch or having everything tied up in one firm or strategy. That being said, I read that he was getting $69 commissions, what kind of accredited investor cant figure out how to sell an option on there own?

For further reading to those interested, there is a very long thread over at futures.io (formerly big mike trading) dedicated to this trading methodology.  It is quite long, but discussions regarding the blow up start here: https://futures.io/options-futures/12309-selling-options-futures-691.html#post697676 

I think you will need to register to read

I'm not an expert in legal matters, and Chris can probably can share more insights, but I believe it was a classic case of misrepresentation. When you market a highly speculative find as a retirement strategy and put your clients IRAs into this strategy, this is definitely a misrepresentation. They will probably claim that OptionSellers.com 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. 

[cuegis 683]

24 minutes ago, Kim said:

I'm not an expert in legal matters, and Chris can probably can share more insights, but I believe it was a classic case of misrepresentation. When you market a highly speculative find as a retirement strategy and put your clients IRAs into this strategy, this is definitely a misrepresentation. They will probably claim that OptionSellers.com 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. 

I am just wondering how much, if any, culpability INTL FC Stone (the clearing firm) will have for looking the other way for so many years , while they full well knew exactly what was going on....Selling uncovered, naked options, on the most highly leveraged instruments in IRA's, and similar.

 

My biggest worry is sort of selfish, as I hope that this does not cause the regulators to start making changes in the SPAN margin rules, which, when used responsibly, can help to produce some very good returns.

I would say that this irresponsible use of SPAN is the exception by far, and not the rule, otherwise you would have seen this sort of thing happen with much greater regularity.

[cwelsh 1,549]

Cuegis:

 

 

 One thing I wanted to clarify, because it's a common misconception, is that limited partners CAN lose more than their original investment, if the fund documents provide for it.  This is particularly common in real estate funds where investors are subject to capital calls to meet tenant improvement budgets that aren't fully known up front.  You normally see these fully disclosed though and investors experienced in the area aren't phased by it -- but you can go above and beyond original investments.

 

Similarly, you can sometimes allow for funds to have capital calls in non-real estate as well, particularly in high risk strategies where the risk of loss may be a known factor.  This is why reading subscription agreements is so important.

 

Regardless, this didn't happen here as far as I can tell.

 

As for whether or not the broker will have any liability....I'm VERY interested in that as well.  Because typically they don't.  However, there is ZERO chance that James would not have had to be registered, at least as a CTA (I don't know if he was or not).  If he was not, and they let him trade these accounts....then maybe.

 

As for will they have liability for blowing up accounts? Highly unlikely.  They are not responsible for the trades people place in their accounts.  In fact the blowup happened because of margin calls that couldn't be met.  By all accounts, that means they were doing their job.  I've been subject to a margin call before on a position I did NOT want liquidated.  Margin might have gone from $5,000 to $10,000.  Then you just have to put up the additional cash -- which increases risk.  

 

This is why I think all of the accredited investor rules are stupid by the way.  I've found people with money are MORE likely not to read or understand what they're getting into than someone who has $50,000 and that's their total net worth.  

[cwelsh 1,549]

3 hours ago, lrfsdad said:

If all the proper paperwork was taken care of at account opening, I don't know how the clients can sue him.  Ive had managed futures accounts blow up and I never thought of suing anyone.  If the steady options fund goes bust can people sue?  If the stock market tanks worse than '08 can mutual fund companies be sued?  I would think risk disclosures are signed for a reason.  At least it was "accredited" investors who should know what they are getting into, not an average Joe who just lost their life savings based on a sales pitch or having everything tied up in one firm or strategy. That being said, I read that he was getting $69 commissions, what kind of accredited investor cant figure out how to sell an option on there own?

For further reading to those interested, there is a very long thread over at futures.io (formerly big mike trading) dedicated to this trading methodology.  It is quite long, but discussions regarding the blow up start here: https://futures.io/options-futures/12309-selling-options-futures-691.html#post697676 

I think you will need to register to read

The basis for any suit would like be misrepresentations.  For instance, I've read that he couched this as a "very safe investment" suitable for "entire retirement accounts" (I've not vetted those statements, just simple news pieces).  If so, he probably opened himself up to liability.

 

Also, you do mention all of the proper paper work, I have a very strong suspicion that was not the case, but who knows, maybe.  

 

But, let's be honest, when you blow a fund like this up, you're probably broke too, so I'm not sure suing serves any purpose.

 

Or maybe he didn't invest in his own "fund" and strategies, and the lawyers will take him to the cleaners.  

[drcruz 116]

1 hour ago, cuegis said:

My biggest worry is sort of selfish, as I hope that this does not cause the regulators to start making changes in the SPAN margin rules, which, when used responsibly, can help to produce some very good returns.

I would say that this irresponsible use of SPAN is the exception by far, and not the rule, otherwise you would have seen this sort of thing happen with much greater regularity

EXACTLY! As one with a smaller account, I've got enough headache with the rules that are meant to "protect" me. It was SUCH A HASSLE to allow my 401K to trade naked puts and I KNOW I have to be fully cash secured. 

[cuegis 683]

44 minutes ago, cwelsh said:

But, let's be honest, when you blow a fund like this up

Remember..this was not any sort of "fund".

They were individual accounts who gave power of attorney (or written authority) to allow Cordier, and likely others, to do whatever they want with these accounts.

There was no "fund" of any kind, as far as I can see.

And, as for the margin calls, and Cordier's claims that the markets just moved way too fast for their "risk management program" ( yeah right), to have the time to liquidate in time.

 

These markets are open 23 hours a day (options too) and are very liquid during all of those hours.

A few days prior to the "final" blowout, there was day #1 where Gas was up more than it has ever been in some 16 years, but,...it was immediately followed the very next day, by the largest DOWN move in an equal period of history...they could have gotten out on THAT day,and there was always 23 hours a day to do it.

[againstallodds 15]

On NFA, Optionsellers.com has been registered since 1999. Link below:

https://www.nfa.futures.org/basicnet/Details.aspx?entityid=fmbUpB706H4%3d&rn=N

 

Back in 2013, Cordier was sued by a client for (i think) unauthorized trading, and lost. https://www.cftc.gov/sites/default/files/idc/groups/public/@lrdispositions/documents/legalpleading/idyragtraders121213.pdf

 

 

 

Edited November 26, 2018 by againstallodds
styling

[cuegis 683]

49 minutes ago, againstallodds said:

On NFA, Optionsellers.com has been registered since 1999. Link below:

https://www.nfa.futures.org/basicnet/Details.aspx?entityid=fmbUpB706H4%3d&rn=N

 

Back in 2013, Cordier was sued by a client for (i think) unauthorized trading, and lost. https://www.cftc.gov/sites/default/files/idc/groups/public/@lrdispositions/documents/legalpleading/idyragtraders121213.pdf

 

 

 

You are correct.

After some digging, a few months ago, I had come across that link from 2013.

That's what makes it even worse.

If someone like me, who has no involvement with them, can locate this, just out of curiosity...then you would think that, out of the 290 "high net worth" investors, some percentage of them would have done the same, or much more, due diligence, and found this same thing.. and avoided opening a "minimum" account of $1 million.

 

 

[cwelsh 1,549]

2 hours ago, cuegis said:

You are correct.

After some digging, a few months ago, I had come across that link from 2013.

That's what makes it even worse.

If someone like me, who has no involvement with them, can locate this, just out of curiosity...then you would think that, out of the 290 "high net worth" investors, some percentage of them would have done the same, or much more, due diligence, and found this same thing.. and avoided opening a "minimum" account of $1 million.

 

 

I just read that and three things stand out:

 

1. As far as orders go, that's not that damning.  He got whacked because, when getting his client's paperwork, missed the signature on the power of attorney.  There were no allegations of fraud and it basically looks like the client got lucky in his suit on a technicality (but an important one).  The client signed up for the account, transferred the money, the broker acted as if the POA had been received....they just missed one piece of paperwork.  It can happen;

2. The arbitrator did NOT find that he violated his trading methods.  In fact, he basically said there was no evidence to support that Jason had taken any wild positions; BUT

3.  In a year, the account steadily went down...and down....and down....and down...….and they did nothing about it and completely underestimated risk, time and time again.  

[cuegis 683]

9 hours ago, cwelsh said:

I just read that and three things stand out:

 

1. As far as orders go, that's not that damning.  He got whacked because, when getting his client's paperwork, missed the signature on the power of attorney.  There were no allegations of fraud and it basically looks like the client got lucky in his suit on a technicality (but an important one).  The client signed up for the account, transferred the money, the broker acted as if the POA had been received....they just missed one piece of paperwork.  It can happen;

2. The arbitrator did NOT find that he violated his trading methods.  In fact, he basically said there was no evidence to support that Jason had taken any wild positions; BUT

3.  In a year, the account steadily went down...and down....and down....and down...….and they did nothing about it and completely underestimated risk, time and time again.  

Yes.. if we are talking about the same case it seems like the guy complaining was pretty confused on his own.

He kept changing his mind and didn't seem to know what he wanted.

But, the important part, that any new customer should have paid attention to was point #3 showing the consistent loss of money using their "low risk" techniques.