Streetwise Professor

November 24, 2018

This Is What Happens When You Slip Picking Up Nickels In Front of a Steamroller

Filed under: Commodities,Derivatives,Energy,Exchanges — cpirrong @ 7:14 pm

There are times when going viral is good.  There are times it ain’t.  This is one of those ain’t times.  Being the hedgie equivalent of Jimmy Swaggert, delivering a tearful apology, is not a good look.

James Cordier ran a hedge fund that blowed up real good.   The fund’s strategy was to sell options, collect the premium, and keep fingers crossed that the markets would not move bigly.  Well, sold NG and crude options in front of major price moves, and poof! Customer money went up the spout.

Cordier refers to these price moves as “rogue waves.”  Well, as I said in my widowmaker post from last week, the natural gas market was primed for a violent move: low inventories going into the heating season made the market vulnerable to a cold snap, which duly materialized, and sent the market hurtling upwards.   The low pressure system was clearly visible on the map, and the risk of big waves was clear: a rogue wave out of the blue this wasn’t.

As for crude, the geopolitical, demand, and output (particularly Permian) risks have also been crystalizing all autumn.  Again, this was not a rogue wave.

I’m guessing that Cordier was short natural gas calls, and short crude oil puts, or straddles/strangles on these commodities.  Oopsie.

Selling options as an investment strategy is like picking up nickels in front of a steamroller.  You can make some money if you don’t slip.  If you slip, you get crushed.  Cordier slipped.

Selling options as a strategy can be appealing.  It’s not unusual to pick up quite a few nickels, and think: “Hey.  This is easy money!” Then you get complacent.  Then you get crushed.

Selling options is effectively selling insurance against large price moves.  You are rewarded with a risk premium, but that isn’t free money.  It is the reward for suffering large losses periodically.

It’s not just neophytes that get taken in.  In the months before Black Monday, floor traders on CBOE and CME thought shorting out-of-the-money, short-dated options on the S&Ps was like an annuity.  Collect the premium, watch them expire out-of-the-money, and do it again.   Then the Crash of ’87 happened, and all of the modest gains that had accumulated disappeared in a day.

Ask Mr. Cordier–and his “family”–about that.


Print Friendly, PDF & Email


  1. I knew people that shorted out of the money Treasury/Eurodollar options. Thermonuclear money explosion. You can short, but you have to hedge in the underlying. Short calls, buy the underlying so you are delta neutral, etc…..

    Comment by jeff — November 25, 2018 @ 11:05 am

  2. Isn’t it more likely he was short Oil puts and short NG Calls?

    Comment by NJ Fan — November 25, 2018 @ 11:58 am

  3. It’s not always true, but it often comes down to a simple question. Can you take a loss?

    Question 1: Do you have stop losses and do you adhere to them?

    Question 2: Do you size your positions so liquidity will exist so you can execute your stop loss and survive?

    If either answer is no, move on.

    Comment by Highgamma — November 25, 2018 @ 11:51 pm

  4. @Jeff, I don’t think there was any point in hedging those positions. I put the probability of that monkey having any edge in those trades at pretty close to zero, so he would have just been hedging in either a small loss or, at best, no return at all. Hedging only protects edge in your trade and do you really think that he was buying below fair and selling above fair? No way.

    Comment by Methinks — December 3, 2018 @ 1:45 pm

RSS feed for comments on this post. TrackBack URI

Leave a comment

Powered by WordPress