Almost got wiped out! How to stop it happening again?

Some 10 years ago as a naive Uni student I dabbled in trading Options. I was a client of a large broking firm and in hindsight, was trading on a whim and some shallow advice from my broker.

I was mostly writing call and put spreads to collect the premiums. Whilst I understood the derivatives I was trading, I had no knowledge of expectancy, money management etc. On occasions I was risking ~50% of my account ron single positions! This makes me quiver when I think back to it all now!

There was one super scary moment though. I had a call spread on RIO (e.g. short 5 x $50.00 calls on RIO, long 5 x $51.00 calls) and it was in the money (which you don't want when you are short a call credit spread).

I received a letter from my broker basically saying "RIO has conducted a share buyback (or similar corporate action) and as such, due to your position, you will be due to cover this position".

At the time, I thought very little of this. "My Broker will call me if there is anything I need to be aware of". My broker did call me, almost in tears "mate, sorry about this, I don't know how this happened, but due to this corporate action, you need to pay ~$50,000"

Did this mean if I had of been long I would have received $50,000?

Hmmmm, this is not the kind of thing a uni student wants to hear!

I wrote the firm a letter reminding them that they were a full service broker and that I was never warned of this; I would not be paying a cent. Luckily; I received a reply saying they would cover all exposure. I only heard back from that broker some 9 years latter when he started work at another firm (Will name names to any interested people). Apparently he copped most of the losses and I'm assuming also lost his job.

Anyway...

I'm about to dip my toe into trading again. This time I am well armed with knowledge about risk & money management, expectancy, etc.

I'm looking at CFDs to give me leverage and also shares to start investing.

My concern is, after almost being wiped out by this corporate action, how do I stop it happening again? I can pull letters out of the archives with exact details, but as I recall, it was basically a corporate action by RIO, and since I was short (wrote a call) on RIO that was in the money, I was then liable to the purchaser of the call.

So what would happen if I was short XYZ with CFDs and they had a similar corporate action? Would I have a chance to get out before being liable? Or once the action was announced I'd be stuffed? I'd obviously have stop losses in place to protect me from capital loss, but what about these other losses?

Also, if I start writing options again, how can I stop a similar thing happening again?

It's one thing to make 2R, 3R, 4R profits; but if a 30-50R loss comes along! Ahhhhhh!

Perhaps this is why paying an arm and a leg for brokerage is worth it, to have a professional warn me about things like this.

Cheers

Re: Almost got wiped out! How to stop it happening again.

RazzaDazzla said:

On occasions I was risking ~50% of my account ron single positions!

Click to expand...

Simple...learn money management

Re: Almost got wiped out! How to stop it happening again.

RazzaDazzla said:

There was one super scary moment though. I had a call spread on RIO (e.g. short 5 x $50.00 calls on RIO, long 5 x $51.00 calls) and it was in the money (which you don't want when you are short a call credit spread).

I received a letter from my broker basically saying "RIO has conducted a share buyback (or similar corporate action) and as such, due to your position, you will be due to cover this position".

At the time, I thought very little of this. "My Broker will call me if there is anything I need to be aware of". My broker did call me, almost in tears "mate, sorry about this, I don't know how this happened, but due to this corporate action, you need to pay ~$50,000"

Click to expand...

Hi RazzaDazzla,

The bit i don't get is how could you have been liable for 50K when the max at risk on your spread was 5K - premium received.

As far as take over/ corporate action goes when playing with options i guess it just a matter of being sensible, i.e. no naked shorts on stock options is the most obvious but the subject of options is pretty involved for one reply, if you really want to play it safe, sensible index option strategies are the go.

CFD's, i dunno if a takeover is announced and your short could get scary, so far i've only had experience in SPI futures with the intent not to speculate, more to augment my options trading.

That's all i can say at the moment, good luck with your choice.

Re: Almost got wiped out! How to stop it happening again.

RazzaDazzla said:

Anyway...

I'm about to dip my toe into trading again. This time I am well armed with knowledge about risk & money management, expectancy, etc.

I'm looking at CFDs to give me leverage and also shares to start investing.

My concern is, after almost being wiped out by this corporate action, how do I stop it happening again? I can pull letters out of the archives with exact details, but as I recall, it was basically a corporate action by RIO, and since I was short (wrote a call) on RIO that was in the money, I was then liable to the purchaser of the call.

So what would happen if I was short XYZ with CFDs and they had a similar corporate action? Would I have a chance to get out before being liable? Or once the action was announced I'd be stuffed? I'd obviously have stop losses in place to protect me from capital loss, but what about these other losses?

Also, if I start writing options again, how can I stop a similar thing happening again?

It's one thing to make 2R, 3R, 4R profits; but if a 30-50R loss comes along! Ahhhhhh!

Perhaps this is why paying an arm and a leg for brokerage is worth it, to have a professional warn me about things like this.

Cheers

Click to expand...

In addition to Sammys answer

My novice opinion

In respect of CFDs you can implement "guaranteed stop losses" with some CFD providers, which would limit your loss to a maximum quantifiable amount.

Of course, a fee is charged for this.

With ordinary stop loss, you could still get gapped down, so your maximum loss is not certain

I'm not sure what "other losses" you refer to, but if it means losses that might be 10R etc, because you are going to use options, then you need to understand the risks, if you dont, then best to avoid them, or use a full service broker, like you did, which reduces the risk, ( you did not have to pay), but does not entirely eliminate.

You may have been fortunate to be compensated

There are some good options guys on this forum, hopefully they can comment on broker risk.

Any comments about systemic risk from CFD providers would be interesting, for me anyway

Re: Almost got wiped out! How to stop it happening again.

Hi Razzla,

Sammy has good advice, but sounds like you got caught up in something extraordinary.

I can't understand how you got hammered either, can you explain a little bit more about the mechanics of what happened?

Thanks

Re: Almost got wiped out! How to stop it happening again.

RazzaDazzla said:

So what would happen if I was short XYZ with CFDs and they had a similar corporate action? Would I have a chance to get out before being liable? Or once the action was announced I'd be stuffed? I'd obviously have stop losses in place to protect me from capital loss, but what about these other losses?

Click to expand...

Of course the answer is no! If you have a chance to get out, do I have a chance to get in? Then everyone would just be printing money.

Never short a potential takeover target is a must. Using guaranteed stop loss is another possibility.

BTW, RazzaDazzle... I've heard your story before. Did you post it somewhere previously?

Re: Almost got wiped out! How to stop it happening again.

wayneL said:

Hi Razzla,

Sammy has good advice, but sounds like you got caught up in something extraordinary.

I can't understand how you got hammered either, can you explain a little bit more about the mechanics of what happened?

Thanks

Click to expand...

Wayne:
Thanks for understanding. Yeah, my point of my post was that I was most definitely caught up in something extraordinary.

So thanks for the posts everyone re. my lack of trading discipline etc. The purpose of my post is to find out:
a)How I was liable for such a huge amount
b)has anyone heard of such a thing happening before?
b)How to stop this happening again.

Wayne:
I'll go through the filing cabinet tomorrow and pull out the exact letters. It truly was an extrodinary situation. It was above and beyond the scope of normal option trading. My loss was not due to rpice movement. I had my losses guaranteed (call spread so I sold a call and bought a call).

Re: Almost got wiped out! How to stop it happening again.

RazzaDazzla said:

Wayne:
Thanks for understanding. Yeah, my point of my post was that I was most definitely caught up in something extraordinary.

So thanks for the posts everyone re. my lack of trading discipline etc. The purpose of my post is to find out:
a)How I was liable for such a huge amount
b)has anyone heard of such a thing happening before?
b)How to stop this happening again.

Wayne:
I'll go through the filing cabinet tomorrow and pull out the exact letters. It truly was an extrodinary situation. It was above and beyond the scope of normal option trading. My loss was not due to rpice movement. I had my losses guaranteed (call spread so I sold a call and bought a call).

Click to expand...

OK Razzla that would be good. I'd be really interested to find out.

The only thing I can think of right now is that you were assigned early on your ITM short call and the stock gapped down overnight.

I have heard of certain rare situations involving short stock/option combos... researching....

Re: Almost got wiped out! How to stop it happening again.

may be of some relevance

if you are talking about ten years ago around 98/99 rio's sp was trading around $12-$15

the cost you mention of 50k could be take into account as the price of having to purchase the shares x 5 contracts when your short calls were exercised

if your longs were itm they should have been exercised therefore only creating a loss of the 5k

Re: Almost got wiped out! How to stop it happening again.

jackson8 said:

may be of some relevance

if you are talking about ten years ago around 98/99 rio's sp was trading around $12-$15

the cost you mention of 50k could be take into account as the price of having to purchase the shares x 5 contracts when your short calls were exercised

if your longs were itm they should have been exercised therefore only creating a loss of the 5k

Click to expand...

Razzla said he was trading the $50-$51 debit call. That's an underlying face value of $250,000.

$50,000 represents a 20% move in the underlying. Not impossible in a corporate action... rights issue or whatever. Particularly if the broker had to close out the shorts in the pre-market due to insufficient funds in the account.

Re: Almost got wiped out! How to stop it happening again.

There was one super scary moment though. I had a call spread on RIO (e.g. short 5 x $50.00 calls on RIO, long 5 x $51.00 calls) and it was in the money (which you don't want when you are short a call credit spread).


just to clarify razza
was it a debit or credit spread and are the strikes you have quoted for example purposes only
as i previously mentioned the time frame you have quoted places sp around 13-15 $

Re: Almost got wiped out! How to stop it happening again.

wayneL said:

Razzla said he was trading the $50-$51 debit call. That's an underlying face value of $250,000.

$50,000 represents a 20% move in the underlying. Not impossible in a corporate action... rights issue or whatever. Particularly if the broker had to close out the shorts in the pre-market due to insufficient funds in the account.

Click to expand...

That's actually @rse about. Will wait for details.

Re: Almost got wiped out! How to stop it happening again.

Sumfin not right about this post?? I have heard/seen/dreamed it before?

Re: Almost got wiped out! How to stop it happening again.

Guarantee stops - For most shares its min 5% away from last price. Thats for ASX Majors. Quite a large prem charged; usually not worth it.

Corporate Actions - With CFDs, your stops, entry price, are adjusted for corp actions like Rights issues, splits... Obviously not for takeovers etc.

If you have sensible risk management, you can shrug off corporate actions. 20% prem takeover bid while you're short? Thats ok. Close out your position, lose 5% of your account. Sure its a hit but it should never come close to wiping you.

Re: Almost got wiped out! How to stop it happening again.

RazzaDazzla said:

Some 10 years ago as a naive Uni student I dabbled in trading Options. I was a client of a large broking firm and in hindsight, was trading on a whim and some shallow advice from my broker.

I was mostly writing call and put spreads to collect the premiums. Whilst I understood the derivatives I was trading, I had no knowledge of expectancy, money management etc. On occasions I was risking ~50% of my account ron single positions! This makes me quiver when I think back to it all now!

There was one super scary moment though. I had a call spread on RIO (e.g. short 5 x $50.00 calls on RIO, long 5 x $51.00 calls) and it was in the money (which you don't want when you are short a call credit spread).

I received a letter from my broker basically saying "RIO has conducted a share buyback (or similar corporate action) and as such, due to your position, you will be due to cover this position".

At the time, I thought very little of this. "My Broker will call me if there is anything I need to be aware of". My broker did call me, almost in tears "mate, sorry about this, I don't know how this happened, but due to this corporate action, you need to pay ~$50,000"

Did this mean if I had of been long I would have received $50,000?

Hmmmm, this is not the kind of thing a uni student wants to hear!

I wrote the firm a letter reminding them that they were a full service broker and that I was never warned of this; I would not be paying a cent. Luckily; I received a reply saying they would cover all exposure. I only heard back from that broker some 9 years latter when he started work at another firm (Will name names to any interested people). Apparently he copped most of the losses and I'm assuming also lost his job.

Anyway...

I'm about to dip my toe into trading again. This time I am well armed with knowledge about risk & money management, expectancy, etc.

I'm looking at CFDs to give me leverage and also shares to start investing.

My concern is, after almost being wiped out by this corporate action, how do I stop it happening again? I can pull letters out of the archives with exact details, but as I recall, it was basically a corporate action by RIO, and since I was short (wrote a call) on RIO that was in the money, I was then liable to the purchaser of the call.

So what would happen if I was short XYZ with CFDs and they had a similar corporate action? Would I have a chance to get out before being liable? Or once the action was announced I'd be stuffed? I'd obviously have stop losses in place to protect me from capital loss, but what about these other losses?

Also, if I start writing options again, how can I stop a similar thing happening again?

It's one thing to make 2R, 3R, 4R profits; but if a 30-50R loss comes along! Ahhhhhh!

Perhaps this is why paying an arm and a leg for brokerage is worth it, to have a professional warn me about things like this.

Cheers

Click to expand...

STOPLOSS.
MONEY MANAGEMENT.

Re: Almost got wiped out! How to stop it happening again.

Razza, whatever the reasons end up being for such a situation to occur, hope it does'nt completely taint your view of options. Options like many other vehicles can be used in many ways.

Thanks for the interest guys.

I have found the paperwork. I am happy to scan the docs (with some censoring) and post somewhere if anyone's interested.

From a skim over the paperwork it looks like this:

- 24/02/2005: Sold 5 RIO 23/3/2005 Calls @ $1.665
Bought 5 RIO 23/3/2005 Calls @ $1.06
Share price was $45 at the time (this makes me shudder looking back at these past trades! I know I am responsible for my own actions, but this really was being led half blind by my broker)

- The corporate action was an off market buy back on 24 March 2005 (sorry for the bum steer re dates)

- My written call was in the money and was exercised. Obviously to take advantage of this. 4 were exercised, the other call position was closed out by me

- Extract from first letter received from firm 20 April 2005
Date of sale 17/3/2005 (I assume this is exercised date)
Contract note number #######
Number of units 4000

Ex Date 18/3/2005
Record Date 24/3/2005
Tender Period Opens 18/4/2005
Tender period closes 6/5/2005

"This company has been quoted 'ex buyback' on 18/3/2005. As these shares were sold 'cum' on this date, the entitlement to the buyback is due to the buyer of your shares... As such, you are required to provide protection to the buying clients by passing on all entitlements buyers are entitled to under provisions of the buyback."

-
- Extract from second letter from firm dated 18 May 2005
"As a result of the assignment of the RIO Call options, a short cum entitlement position in your RIO holdings has arisen. That is, you do not have sufficent RIO shares, cum entitlement, to satisfy your obligations under your sale agreement. As you are no doubt aware, under ASX rules you are required to protect the purchaser of your RIO shares for the shortfall (calculation below)

We now advise that on 9 May 2005 Rio announced the final result of the companys off market share buyback plan. The final pricing of the share buyback is $36.70 per share

As a result of the completion of lodgement of claims from purchasers requiring protection to participate in the RIO buy back plan, we have calculated the pro-rata claim against your account as follows. the reduction in the claim against your account is a result of the total number of purchasers participating in the protection claim being reduced due to the various final pricing options selected on offer.

Number of shares subject to protection 4000
Final number of shares requiring protection 2289

Capital component per share $4.00
Dividend component per share $32.70
Imputation Credit (30% per share) $14.01 (cash)

Total cash claim per share $50.71
Cash received from sale of entitled shares $44.60 (????)
Shortfall per share $6.11

Total debit to your account (2289 shares) $13,985.79


- The final amount of protection I was required to provide was $13,985.79 (not $50,000 sorry again for the bum steer, but this number stuck in my head as this was what I remember my broker saying when he was almost crying to me over the phone)

As stated previously, I wrote a firm letter to my firm saying:-
- you're a full service broker, that's what I pay for, I rely on your advice, you should have warned me of this so I would have had the opportunity to close this position.

I was then very lucky that "as a gesture of goodwill" the firm covered me. Phew!

So from my understanding:
-Calls were in the money, 4 of them were exercised to take advantage of the off market buyback
- When I wrote the calls, the shares were Ex BuyBack (as this hadn't been announced)
- When I was exercised, the shares were then Cum BuyBack
- I then had to cover this shortfall.

I see this BuyBack affecting the shares the ame way as if RIO announced a 'special dividend'. I don't have any hisotircal data on me, but it looks as though the share price sat between my longs calls of $45 and my short calls of $44.

I have ????? above on Cash received from sale of entitled shares $44.60 as I don't understand how the shares were sold at $44.60

what could have been done at the time to avoid this? Could I have shut down my in the money position as soon as an announcement was made re. a buyback? I'm guessing Once the announcement was made and I got exercised, that was it, I needed to provide protection.

would there have been any 'warning shots' prior to the announcement? Any opportunity for me to get out of the position? Or once the announcement of a buyback being offered, that was it. Or would there have been an announcement saying "hey, we're going to do a buyback, stand by and we'll confirm the price"

Then I could have got out before the

"OK, here's the final price of the buyback" announcement.

So to avoid this in the future, I would need to:
- Keep a solid eye on company announcements on any stock I am in a position with
- If I am "in the money", shut down those positions the moment any announcements are made re. buybacks, special dividends etc. so as not to be exercised

Cheers for reading everyone, hope someone learns something from this.

hi razza

did your long calls which you had purchased for upside protection have any value in them after announcement as could have been sold to recoup a partial amount

looks like the ann date was within a few days of expiry date so unless the sp was trading close to your bought calls they may have had little value

Hi Razza

Here's the lessons we can take from your experience.

1. Brokers are muppets
2. Always check for upcoming corporate actions, including dividends, before taking a trade.
3. If you don't know how it will affect your trade, stay out, if already in, get out.
4. ITM options can be assigned at any time, calls, particularly when the buyer wants to benefit, puts, when cost of carry on their share greater than the premium.
5. Credit spreads, though they have their place, are not the "one size fits all" get rich quick strategy they are often promoted as.
6. Shift the goalposts as necessary (adjust/morph your position when threatened)
7. Brokers are muppets

.

The biggest lesson is to take the time to understand these puppies, Greeks, the whole shebang. Captain your own boat -know your stuff and fear no man - be able to see straight through the utter bullsh!t promulgated in the option world.

And as Grinder suggested, don't blame the options, they did the job they were designed to do. You were unlucky in one sense, but a quick perusal of the the companies announcements (or a competent broker) would have saved you the agro.

FWIW

Good luck

Hi Razza

I'm sorry to hear your terrible experience, I'm a uni student myself and if I heard from my broker I owe some 14k I would have....... bang my head on the wall literally...

It seems like a lot of time we only get to learn those kind of lessons/stuffs is through rude awakening (or in your case a call from your incompetent broker)

Anyway your questions was what could have been done at the time to avoid this? I think there is nothing that could be done about your option trades when a corporate action like that is announced (or unless you close off your positions before the other guy get to exercise it first).

However before the corporate actions your broker should at least let you know how might the scenario played out. Other than that, everything WayneL said on the previous post I stand by it!