
Wiped-Out Hedge Fund Manager Confessed His Losses on YouTube - pdog
https://www.bloomberg.com/news/articles/2018-11-19/hedge-fund-s-accounts-liquidated-amid-energy-market-volatility
======
chollida1
Such is the life of an option seller, especially naked option sellers. You are
picking up the proverbial nickle in front of the steam roller.

The really unfortunate part of this is that some of his clients actually owe
more money than what was in their account.

There is a scummy way of managing money that some CTA's use where you don't
get the proper license to manage others money as a hedge fund and instead just
have people put money into accounts and then they give you the right to trade.
Due to the use of leverage when the market moved against their naked short Nat
Gas positions all the collateral posted in the accounts were not enough to
covert the losses so some people are not only out the amount they wagered, but
more.

And the worst part of it is the manager blaming this on an unforeseen event.
Everyone who sells options knows that rule one is never be naked when you are
short as your losses can be unbounded.

The reason for this is that if you have traded for even a short period of time
you realized that while the market is liquid most of hte time, there are times
when its not and the only thing you can do is watch it move while realizing
you can't exit a position.

This happend to short sellers of KBIO when they thought they were riding a
shitty stock to zero, when Martin Shkreli bought it for a premium causing
margin calls for everyone short it.

See:

[https://www.investopedia.com/articles/investing/112315/did-m...](https://www.investopedia.com/articles/investing/112315/did-
martin-shkreli-intentionally-burn-kalobios-shorts.asp)

As a side note Martin has a blog.
[http://martinshkreli.com/](http://martinshkreli.com/)

its actually pretty good as this is what he does for a living and when hes out
of prison he's going to try and go back to it so this is really the only way
he can redeem his brand. I expect him to put everything he has into the blog.
its' a good source of trading ideas.

TL/DR

\- never sell options

\- if you do then never sell naked options

\- if you do make sure you can get out of your trade

\- if you can't get out of your trade make sure you are well capitalized for
loss absorption

\- if don't have enough to cover your losses don't apologize for losing your
clients money while wearing a $10,000 watch and post it for the rest of the
world to see.

~~~
AznHisoka
Why would his clients owe money? The fund is the one doing the trading, so
it's the fund that would owe money.

~~~
whatok
They were setup as managed accounts. Clients actually own the assets and in
turn the liabilities.

~~~
AznHisoka
Got it. Seems weird anyone would sign up for something like that.

~~~
olliej
I’m sure it was “cheaper” or they were friends/acquaintances and he just said
“I can make you money” - because he wasn’t a “real” (eg with the presumably
expensive accounts and control systems) it was probably easiest to have it set
up that way.

Question for people who understand things better than me: isn’t setting up an
LLC in America quite cheap? Couldn’t an individual make an LLC to hold their
investment funds, and then give him control of those accounts? Wouldn’t the
LLC protect them? (Not saying that such a layer is free, but it seems like a
relatively cheap protection)

~~~
whatok
Without getting into specifics, some investors prefer separately managed
accounts. It has nothing to do with difficulty of setting things up and
everything to do with preference. That said, if for some reason I wanted to
invest in something that sold naked options, I would prefer to invest with an
LLC.

~~~
tomp
Aren't managed accounts orthogonal to liability? e.g. if I wanted to invest my
money in a managed account, I could _still_ set up (my own) LLC to limit
liability (and that could be better even for e.g. tax reasons).

~~~
SubuSS
What prevents people from setting up such LLCs and go nuts on such naked
options? I mean you can bankrupt the company if they go wrong, reap it if it
works out. I am sure I am missing some gaping hole there.

~~~
tomp
Yeah, options are either traded on an exchange, in which case the exchange
should ensure that its members/participants have enough capital to cover the
trades, and that makes the exchange itself liable (i.e. the exchange is the
counterparty) - see e.g. the recent case of an energy trader going belly up in
Norway [1] - he wiped out the whole emergency fund set up by the exchange
itself, as well as a huge chunk of the secondary emergency fund set up by the
exchange members. Otherwise, you're trading options OTC i.e. directly with
another counterparty (e.g. an investment bank, private trader, etc), in which
case the other party bears "counterparty risk" (i.e. the proximal cause of the
last financial crisis - "will the bank that I've $100bn of exposure to still
exist tomorrow or not") which they should manage and/or enforce in court if
necessary (i.e. options are just contracts).

TL;DR: the person on the other side of the transaction needs to be reasonably
sure you can hold your end of the deal.

[1]
[https://www.forbes.com/sites/heatherfarmbrough/2018/09/14/no...](https://www.forbes.com/sites/heatherfarmbrough/2018/09/14/norwegian-
energy-market-trader-creates-e114m-hole-in-nasdaq-clearing-fund/#621f8746ce57)

------
johnwheeler
I can't believe he'd say, "I owe you a cuban sandwich" to someone whose life-
savings he presumably gambled away on options. I seriously thought this was
the Onion when I heard that.

[https://www.youtube.com/watch?v=VNYNMM0hXXY&feature=youtu.be...](https://www.youtube.com/watch?v=VNYNMM0hXXY&feature=youtu.be&t=128)

~~~
JumpCrisscross
> _someone whose life-savings he presumably gambled away on options_

It’s a stupid line. But nobody with any sense has more than 5% of their
portfolio in a single hedge fund.

~~~
olliej
The problem is that even if they had only 5% in that fund, the way it was
managed meant that they ended up owing more than was originally put in.
Options (or at least naked? Ones) have unbounded loss. You can end up owing
vastly more than you started off with.

~~~
HappySweeney
Only if you sell. Option buyers have a loss floor built-in.

~~~
olliej
My understanding of options was essentially that you borrow N shares of stock
X with a promise to buy it back. You then sell your shares to get so many $$$
(much wow, such bankruptcy ;) ). Then later when the stock goes down you buy
back N shares and pocket the difference, and use those N shares to pay back
your loaned shares.

The problem seems to come from selling your shares and then the stock
unexpectedly (to you at least) rising so that buying back N shares costs you
more money than you necessarily have.

As far as I can make out the way people make “huge amounts” from options is
going down that path.

Are you saying that another common approach is to buy your options and instead
bank on the value of the options themselves increasing?

This is a legit non-sarcastic question as it literally never occurred to me to
do this :)

~~~
HappySweeney
What you are describing is short-selling. An option is a contract to buy (or
sell, depending on the option) 100 shares of some stock at a set price, which
expires at the end of a set day (usually the 3rd Friday). This contract costs
some premium, which is lost if the option expires before the owner exercises
it.

You can indeed make a lot of money just holding the option until it is worth
more, and it can jump several multiples of the original price, especially on
unexpected price movements.

As the option cannot have a negative price, your losses are capped at whatever
you spent on them.

------
Tomminn
I find this difficult to watch.

The only thing that would make this less difficult for me to watch is if he
had his personal fortune invested in his hedge fund also, and so was similarly
wiped out. In which case I'd like to hear it.

Otherwise if I was an investor I couldn't help but think: "sure, but you only
lose our 2 and 20 this year, what happened to the 2 and 20 you made through
the last few decades?".

It would actually be an interesting law:

"Operators of investments must have a higher fraction of their wealth invested
in the fund than any of their investors".

Obviously difficult to implement but the spirit of it is fascinating to me.
That way, when a hedge fund fails, the entity which has been the most ruined
by it (fractionally speaking) is the CEO. It'd create genuine skin in the
game.

~~~
spitfire
That's the idea behind Nicholas Nassim Taleb's most recent book "skin in the
game". People should be exposed to the downside risks of their actions.

~~~
Tomminn
Yeah, I was 100% cribbing off Taleb's broad point, which I'm familiar with. Do
you know if he's suggested this particular idea, or something similar?

------
ilamont
The photo at the top of the article reminded me of a sight in northern New
York, and apparently being duplicated in many parts of the country: Tens of
thousands of obsolete and unneeded tanker cars sitting idle on rural sidings
and unused lines:

[https://www.npr.org/2015/09/14/440173575/what-to-do-with-
rai...](https://www.npr.org/2015/09/14/440173575/what-to-do-with-railroad-
tank-cars-that-are-no-longer-safe-or-economical)

The collection I saw last year next to Route 12 in New York was at least 10
miles long, and there is another one in the Adirondacks. It's an eyesore to
say the least ... possibly a pending environmental hazard. If there's a
declining need for oil to be transported around the country on trains, and the
cars are expensive to recycle or transform, what will happen to them?

~~~
mrunkel
Likely the same thing that happened to all the mills throughout the rust belt.
They'll get abandoned. The pessimist in me says that they'll get sold to a new
corporate entity which will then file for bankruptcy and the government at
some level will need to clean it up.

------
Bootvis
It appears that this fund was mostly in the business of selling options.
Nassim Taleb often warns this is a dumb idea because in the long run something
bad will happen from which you can't recover. I tend to agree and while it's
sad for those involved I believe they can only blame themselves. They haven't
been prudent.

~~~
jhall1468
Options are extremely high risk and should be avoided. Naked options are an
excellent way to part a fool and his money. Investing in anything that
potentially exposes you to unlimited losses is eventually going to expose you
to unlimited losses and you can't make that up with volume.

------
noddy1w
A good thought experiment is to imagine a hedge fund which invests in the
s&p500 all the time, but once per year takes all its capital and sells options
with a 5% return and a roughly 1/20 risk of ruin. On average they beat the
s&p500 by 5% every year, and only explode once every 20 years on average.

If you could charge 2 and 20 and smoothtalk investors the chances that you get
rich before it explodes are pretty good.

Differentiating an investment with a negligible chance of going to zero (like
the s&p500) from one with a small but nonzero chance is difficult until one of
them explodes.

------
hermitdev
This is bad, but $150M lost in the natural gas market is not the worst I've
seen. There was Brian Hunter of Amaranth [1] fame that blew up a $9B hedge
fund with a bad NG trade. Amaranth had to liquidate assets for pennies on the
dollar to cover the margin calls. Wikipedia is note entirely correct, here,
though. It says that JP Morgan & Citadel bought the assets, but it was Citadel
that bought them all at the end of the day. My understanding at the time was
that JPM couldn't calculate in time the risk involved with the assets they
were planning on buying.

[1]
[https://en.wikipedia.org/wiki/Brian_Hunter_(trader)](https://en.wikipedia.org/wiki/Brian_Hunter_\(trader\))

~~~
whatok
Centaurus/John Arnold was another party here. While they were not part of the
liquidation they had ridiculous returns that year as a result of the Amaranth
situation. The book Hedge Hogs is a good read on Amaranth.

Dollar amount aside, I'd argue this is worse in some ways because it dealt
with individual investors who are now figuring out how to fund margin calls.

------
icu
I'm sorry for the destruction of wealth on one side, but the traders on the
other side made a killing.

What happened here is fat tail risk that is always present in the market.

------
apo
Seems like a non-apology. It was all the "rogue wave" that "capsized the
boat."

If a fund can't manage volatility surges, the blame isn't the rogue wave that,
out of nowhere blew everything to smithereens, but the guy who steered right
into it.

It's the difference between being sorry that the house you destroyed with a
car was in your path vs. being sorry for having left the party drunk.

~~~
jhall1468
I mean, nobody can manage volatility 100% of the time when they are selling
naked options.

------
tlrobinson
I have no experience investing in hedge funds, but I feel like having a name
like "OptionSellers.com" might be a red flag?

~~~
jhall1468
Why? That's literally what he does.

------
DrNuke
Extending this man a hug in this professionally devastating time and hoping
his inner circle makes sure he stays afloat himself.

~~~
whatok
This guy deserves no sympathy. He gambled his client's money in an extremely
irresponsible manner.

~~~
tomp
How do you know he “gambled in an extremely irresponsible manner”? Was he
misrepresenting the risks he was taking in some way? The domain
“optionsellers.com” suggests he was rather transparent...

~~~
whatok
This person claims that they were an investor and put together a spreadsheet
with several days of NG trades. What I see is someone being irresponsible.

[https://twitter.com/waklyn1/status/1064307589578579968](https://twitter.com/waklyn1/status/1064307589578579968)

~~~
jhall1468
That looks like a well-informed investor understanding _full-well_ that they
were buying naked options and the enormous risks associated with that.

~~~
whatok
They were selling options; not buying them. Hard to blow up like that if
you're buying options. Regardless of what the investor did or did not
understand, my point stands; this guy was extremely reckless.

~~~
jhall1468
Whoops, that was an error rather than misunderstanding. Anybody selling naked
options is playing an enormously dangerous game. Any investor throwing money
at a game like this knows the risks, or they wouldn't even know the firm
exists.

~~~
whatok
Like I said above, only talking about dude in charge.

------
nighthawk1
I think now would be a great time to open a new account. What could go wrong?
[https://www.optionsellers.com/accounts/](https://www.optionsellers.com/accounts/)

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Humdeee
Tragic. From the video, I half expected him to put a gun in his mouth at the
end of it.

What happens now for this guy? He mentions it likely wiped out his firm.
Likely? How can anyone who has done this have any chance to remain in
business, and feel secure enough not to even go into hiding? If the losses are
unbounded, can a number of his clients be totally wiped out, even if they were
diversified?

He'll continue to wear a watch worth more than my car, and have a suit worth
more than all my clothes combined. I have a hard time imagining his lifestyle
will even suffer.

~~~
segmondy
You sound envious.

~~~
Humdeee
... his entire reputation is ruined. How does somebody come back from this? I
like sleeping with both eyes closed at night, don't you?

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jorblumesea
This man has no right handling other peoples' money. This is sheer
incompetence.

------
yread
Is there blood in the streets yet?

