It Only Takes ONE Blowup and You’re Out of Business

April 30, 2018

[There is an update to this story at the bottom of the post, skip ahead if you’re already read the first part]

I caught up with a trading friend of mine in Denver this afternoon to chat about what we’re seeing in the markets these days.

After the usual swapping of the usual stories of successes and regrets in the past few months, we got into a very unpleasant topic. He related a story to me of a common trading friend we have that is truly heartbreaking.

He got caught picking up nickels in front of a streamroller when the volatility explosion happened in early February of this year. But he didn’t just get bruised and battered. He literally got destroyed.

This past fall, our friend — a truly smart, talented, and a sweetheart of a guy — had presented to several of us a new strategy he had been trading in 2017 in $SVXY (the ProShares Short VIX ETF). Without getting too lost in the details, his strategy centered around waiting patiently for the nearly monthly 5%-ish dips in $SXVY and then selling naked way-out-of-the-money puts into these declines on the premise that temporary volatility spikes will eventually (and rapidly) “revert.” And when this inevitably happens, the shorted puts will be then be covered at drastically reduced prices, leaving a sizable profit to the short seller in a short period of time.

He had done all the necessary due diligence, performed all the necessary backtests, and was armed with data going back to before the financial crisis to prove his hypothesis that even in tough times, his strategy was a winner. The fact alone that it survived the financial crisis was proof enough to him (and to an extent us too) that he was on to something.

Well, as sometimes happens, friends lose touch with each other for stretches of time. I hadn’t spoken to this friend since late last fall and frankly, I had forgotten all about what he was up to trading wise. Today, I learned what happened:

The strategy he had been employing was working so well that from 2017 into early 2018, he had traded a roughly $1million account up to around $2million. Not bad, right?

Buoyed with confidence in his strategy (why wouldn’t he be?) he started stepping on the gas in early 2018, committing more assets to the trade. When volatility started to spike on January 29th & 30th, this looked like another one of his classic setups to start selling puts on the $SXVY as he had done many times before over the past year. And on January 31 and February 1 as markets bounced and volatility receded, it looked like his script was going to play out as planned once again. Wash, rinse, repeat.

But on Friday February 2, support was broken and the markets began looking dicey.

By Monday evening, he was out of business.

In two trading days, his naked short puts strategy managed to completely wipe out a nearly $2 million trading account, and left him owing his broker nearly $1 million more. As of the time of this writing, he has yet to settle this debt to his broker. His family’s entire life savings went up in smoke. This family, a week earlier a well to-do upper middle class family with beautiful children, suddenly found itself bankrupt.

I’m heartbroken about this right now. Still trying to process what he and his family must be going through.

Keep in mind, I might not have all the details completely accurate as I’ve heard this second hand from someone else, but I’m sure the events as laid out above are pretty close to the mark.

I don’t even know how to approach him about this? Should I call? Email? Offer condolences? Offer to help him try to find some positives in an otherwise horrible situation? I’m sharing this with you because in doing so, it’s helping me sort out how to process this all. Right now, I don’t have any answers. I’m shellshocked.

For the love of God (and I’m not even remotely religious), if you’re an options trader or a leveraged ETF trader, please do not put yourself in a position to lose everything on one trade or one series of trades. What can happen in the market will happen. And it only has to happen to you once to completely ruin your career and quite possibly your family. There is no trade worth risking that much on.

Here’s the chart that will forever be seared into my friend’s brain:

~ @chicagosean

May 18, 2018 Update:

Since publishing this post, I’ve had the opportunity to connect with this friend and hear how he’s doing. I’m extremely happy to report that nearly 10 weeks since the fateful blowup, he and his family are doing ok. As you can imagine, there is some hardship and new unpleasant financial decisions that need to be made on a daily basis, but all things considered, they are surviving.

I was pleased to learn that he has come to peace with what has happened, learned some very valuable life lessons, and was put into a situation in which he had to deeply focus on what is most important in life — prioritizing the love and well-being of his family. It also helps that he has been throughout (and remains so today) gainfully employed with a nice salary and benefits — so that most certainly helps. Though his plans at early Retirement, which were very closely within grasp, have now been dashed.

This is something I harped on in a previous blog post — trading for a living is a sexy idea, but it’s much more practical and rational to do everything you can to make trading just one of many revenue streams. Otherwise, you’re likely putting too much of your working capital at risk, and that no doubt is adversely affecting the trading decisions you’re making. Don’t make this game and harder than in already is.