The death of an options trader: understanding the early exercise of an option spread.

in options-trading •  5 years ago  (edited)

A young options trader recently committed suicide, and it appears that his suicide was prompted by a spread trade which went against him. The suicide note apparently indicates that he believed he was suddenly in $750,000 US Dollars debt. It is believed that in his terror and shame of dooming his family to this insurmountable debt that he committed suicide. I should state that none of us are privy to this young mans thoughts, but the story is reportedly based on a note he left behind explaining his reasons for committing suicide.

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Unfortunately there were immediate reactions to this tragedy to blame the Robinhood trading platform, for being irresponsible and allowing this young man to get this far in debt. These comments were then followed by more callous comments condemning the young man for seeking a shortcut to riches, and that his avarice and greed were the cause of his own demise. I personally condemn these comments as being harsh, cruel and unnecessary. Can there truly be people amongst us who do not feel the anguish of his parents grief?
Are there people so mean as to make such statements while his death is so fresh?

It was not humanities finest hour.

Personally, I was greatly saddened by this young mans death because not only do I think suicide is tragic, whatever the cause, but this one was especially tragic because it appears he was NOT in debt, but that he misinterpreted his platform emails and account balances. Once again I say appears to be, because we will probably never be able to see his emails and balance statements, but we have the information from the news reports. It appears he was trading option spreads and in the money put option spreads very specifically. The news report goes on to state that per Robin Hood half the trade was exercised and a large debit or negative balance was posted in his account. The report says that the second half of the trade done the next day, actually erased the large debit, and the great loss he feared didn’t actually exist. Unfortunately and tragically he committed suicide before the trade fully settled.

I trade these particular type of spreads, so I felt an immediate form of kinship or relationship to this young man because I understand exactly what an early exercise does in this trade, as the American Idiom states: I have walked in his shoes meaning this has happened to me also.

At this point I think a translation and explanation are needed to fully grasp what happened and why he was afraid.

A put spread means you place a two part trade.
Part one is you sell another trader the right to sell you a security, usually a stock, at a certain price, at a certain time, for a fixed period of time. Part two is you buying the option to buy the same number of shares at the same time, same number of contracts as part one, but at different price then part one.

The prices are different by a number called the spread. You as the spread trader profit by capturing a portion of this spread. Now part one is tied to part two and in fact they occur simultaneously.

important point
Now the real magic of options is the multiplier effect of the contract. A contract represents 100 shares. Ten contracts represents 1000 shares. This means you could simultaneously sell contracts worth $750,000 USD, while buying contracts worth $745,000.00 USD, but your account only needs to contain $5000.00 liquid cash, because you cover the stock options you sell with the stock options you buy. But the numbers are scary, so you need to understand them.

I think you should take a moment to understand what I am saying.

A spread trade of 10 contracts bought and ten contracts sold provides a spread. So the young trader did PART ONE; he sold someone the right to sell him an unknown number of contracts, and as PART TWO of this SPREAD trade he also bought the right to buy the same number of contracts of the same security. So no matter how much the first part was, it was balanced by the second part. The difference can’t be more then his account balance.
That is the way spreads work, in general.

THIS BRINGS US TO TWO IMPORTANT DETAILS;

  1. The spread trade has maximum profit and a maximum loss, which every spread trader knows going into the trade. This maximum loss can never be more then all the cash in the account.

  2. However if part one of the trade undergoes what’s called an early exercise of an option, this means that the buyer excercised his right to sell the security at the agreed on price, and the spread trader would initially see this options exercise settlement create a big debit or negative balance in his account, Which would temporarily wipe out the entire balance of his account. But that’s just part one. Part two involves the options that a spread trader buys as part two of the spread. This position would be then be liquidated and erase the negative balance, restore most of his money, except the amount of the maximal loss.

Three more important details:

One: This young man used Robinhood, which is an online broker. So by normal rules he will never be able to place a trade where the loss was greater then his account balance.

Two: Robinhood automatically freezes the amount of cash equal to the maximal loss of any trade.

Three, If he doesn’t have enough cash or securities to cover the trade, Robinhood won’t let him place the trade.**

So, if we examine the facts, unless he exploited a weakness or glitch in the software, which allowed him to place a trade with a loss greater then his account size, he normally would NOT normally be able to create a situation with a $750,000 dollar loss. A normal spread trade would have settled with him only being able to lose his entire liquid account balance. No more, but most likely less.

So, we are brought back to the tragic reality, that if he had waited to let the second part of the trade settle, he would have not been in debt for $750,000 and there would be no reason to kill himself.

Truth be told, I trade put spreads and specifically in the money put spreads just like this young man, and I know from experience that early excercises create an initially frightening negative balance, but I also know that I can sell part two to erase the negative immediately, or if I do nothing, the platform will sell part two the next day. Either one erases the negative balance. debit.

This trade is scary when it gets exercised, even if you understand what’s happening. But sadly he may not have understood. And that almost made me cry. If he was trading spreads, an advanced level trading technique, he was probably a smart person, who could have grown into an amazingly good trader. Life is sometimes sad and my condolences go out to his parents.

Questions? Please comment below. Don’t be afraid, this is pretty advanced option trading concept, where not many spread traders like to go to trade.

Options trading is a fascinating universe full of atypical trading strategies. But I think a mentor or a responsive help desk are essential.

@shortsegments

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Title: The death of an options trader: understanding in the money put spread exercise procedures properly.

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Interesante tema, algo complicado para entenderlo rápido, gracias por la información, feliz día

Thank you

Siempre a la orden

!shop

Thank you

  ·  5 years ago 

你好鸭,shortsegments!

@eii给您叫了一份外卖!

精装版带榛果 大颗粒 不加价

吃饱了吗?跟我猜拳吧! 石头,剪刀,布~

如果您对我的服务满意,请不要吝啬您的点赞~

Thank you

石头

  ·  5 years ago 


You win!!!! 你赢了! 给你1枚SHOP币!

Greetings appreciate @shortsegments.

I am very surprised that this trader has made this operation for such a significant amount without fully knowing the concept of a SPREAD.

Apparently he did not dominate the operation of this financial tool since he simply had to wait for the second half of the operation to be executed. This leads me to wonder: Perhaps this young man was using foreign funds for this transaction?

The stress that can cause operations of this nature can be increased if the funds belong to a third party. This may have limited the youngster's reasoning ability leading to this tragic decision.

In particular, I do not master the concept of Spread, I have never made this type of transaction. I only limit myself to the basic trading methods that Binance offers: Spot / Margin / Futures.

Thank you for sharing this valuable note with us.

Hi @juanmolina
Thank you for your insightful comments. He truly appears to have lacked command of the tools he was using. Your suggestion of the possibility of him using someone else’s funds definitely increases the stress of trading. 😢

My pleasure. I enjoy reading your writes.

It's pity that the young man committed suicide!! And your comprehensive information in this matter is speechless sir!!
Let me know what was his age at the time of death ?

Thank you for your kind words. I believe he was in his twenties.

  ·  5 years ago (edited)

I'm stunned at his sudden demise but commiting suicide wasn't a good option my condolence to his family, a lesson should be learnt from this young boy greed is actually bad in all aspect of life and this should be avoided.
I think I'm thrilled and I would love to write something about greed in trade.
Thanks for sharing this lesson well learnt.

Your welcome