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A Nightmare in Options trading

Bob Lang

Below is a frightening story of an options trader gone rogue. It is scary because I saw this train wreck happen right in front of me with my own two eyes. I’m sure you have heard stories like this, they are countless. But I for one do not like to see people lose money, at least not without having a chance to win. Now, many of us who trade/invest for a living reside in wide spectrum of fear and greed. As much as you would like to keep the emotions out of the decision-making process it is nearly impossible (that is unless you are an HFT, then you have no emotions – yet the outcome strikes an emotional response).

Many consider option trading as a mysterious activity, only for the bold and reckless. Others consider it pure gambling, but I would argue there are ways to put strong odds in your favor with options. Trading is not a game of perfect, and it certainly is NOT a game to be played when running from behind — at least not with some help. I take my share of bets on the long and short side but using a methodical approach of technical analysis tools and risk management techniques.

Last fall I started managing a client’s account for option trading after a plea for help. He had lost several dollars trading on his own and nothing was working. He had watched and followed me for awhile and approached me to manage his account. At the time I did not know his style, trading size, account size or risk tolerance, but suffice to say after hearing the sum he had lost on his own in such a short period of time - well, I had my suspicions he was a pure gambler (the song by Kenny Rogers floats in my head as I write). He clearly wanted to make back all of his losses – FAST! However, I told him emphatically that I will do this MY WAY only, and he agreed.

So, I was asked to manage one account, take ‘some’ risk but give a chance to make some money. I took on the challenge, and ran his account up in the first week 24%. This was due to some good strategic plays on Apple, Mastercard and First Solar. It was an astonishing week, I could not have imagined results being any better. Further, my new client was pleased. Even more, I had taken away his need to risk more, lose more – or at least I thought.

I decided to take some ‘time off’ from trading that account. Yet the client had access to trade it and needed the fix, so he decided to do that on his own without my trade ideas. His risk level and tolerance for pain was high – very high, as he started early in the week to buy out of the money weekly calls and puts, expiring that Friday! Now, I like using weeklies but with respect to volatility, time and price you have to know some limits as to where price can go in a short time frame. You’ll occasionally be right picking a massive move but that is the outlier, happening less than 5% of the time. But he was determined to hit the jackpot – and put his money where is mouth was.

The problem here is that he was putting up far too much on a bet that had little chance to win. Want a casino comparison? How about betting on one number only at roulette over and over again. Odds are less than 3% to hit the number on a normal wheel. So, as you can imagine he blew his account out that week. He came back the next week with another 75K, and that was history by Friday. Take a week off, more money comes in and more low probability bets, yet a few pay off and his account actually goes higher. Happening before my very eyes!

Apple, Google and Amazon were the preferred trades and they were mostly downside. The following week saw a big win on a biotech play and more high risk put plays to follow — as the market soared higher. What would have been a stellar week from the ONE play turned into a loss from the heavy bets on out of the money puts. Everyone has some ‘gamble’ in them, but to what extreme?

I was stunned and amazed, this client needed an intervention badly but who was I to do it? I made some suggestions about taking profits when they were there, cooling off a bit, taking a break, etc. But there was more money to come into this account and more money lost, all told nearly 500K down the drain. The same bets made over and over – the same losses. I don’t know what the situation was – maybe it was chump change, an insignificant amount to the client. Maybe he didn’t care (I doubt that). I get bothered over losing a hundred bucks, but that’s just me.

I’ll conclude on this note: be in control of your account, know your risk tolerance and don’t believe you are in a casino. Options trading is not easy but can be done successfully with the right tools, mentality and outlook. Nothing I could do in trading could have made this client happy other than getting back to even, which was so far away it was nearly impossible to get there without wild bets. You can stay in the game long enough by being respectful to your account and using your knowledge as a tool to grow it over time.