A young man recently died by apparent Suicide, which appeared related to a spread trade which went against him, and he believed he was suddenly in debt to the tune of $750,000 US Dollars. It is believed that in his terror and shame of dooming his family to this insurmountable death 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 suicide.
Unfortunately there were immediate reactions to this tragedy to blame the platform, called Robin Hood for being irresponsible and allowing this young man to get this far in debt.
These comments were then followed by more callous and judgmental comments condemning the young man for seeking a shortcut to riches and these cold blooded commenters even blamed the young man for his own demise due to greed and avarice. These were then followed by a litany of variations and also combinations of these themes.
To be perfectly honest I was greatly saddened by this young mans death because I think suicide is tragic whatever the cause, but this one was especially tragic because it appears to have been a mistake on his part, not in getting into debt, but in interpreting 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 is that he was trading options, option spreads specifically 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 debut was posted in his account.
At this point a translation and explanation are needed to explain what this meant.
A spread means you place a two part trade.
Part one is you sell another trader the right to buy a security, usually a stock, at a certain price, at a certain time, for a fixed period of time. These options are sold in groups of 100 called contracts. Options traders frequently trade 10 to 20 contracts at a time, meaning they are trading options to buy 1000 to 2000 shares of a stock or index share. Now part one is tied to part two and in fact they occur simultaneously. Part two is you buying the option to purchase 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 profitby capturing a portion of this spread. Now the real magic of options is the multiplier effect of the contract. A contract represents 100 shares. Ten contracts represents 1000 shares. The spread is usually small, frequently less then a dollar. But when you multiply that small number by 100, as in one contract or by 1000, as in ten contracts, that spread of 82 cents becomes 82$ or 820$ USD. Now as we say in options trading, we are talking about real money.
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 buy an unknown number of contracts, I will use 10 contracts for the sake of illustration as part one of the trade and as PART TWO of this SPREAD trade he also bought the right to buy 10 contracts of the same security.
That is the way spreads work, in general.
THIS BRINGS US TO TWO IMPORTANT DETAILS;
- 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.
- The trade settles at expiration with simultaneous settlement of both parts and the maximal loss will never be more then his account balance. However if part one of the trade undergoes what’s called an exercise of an option, meaning that the buyer excercised his right to buy the security at the agreed on price or his right to sell the security at the agreed on price, the spread trader would initially see part one settlement showing 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 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.
Two more important details:
One: This young man used Robinhood, which is an online broker. So by definition the platform is primarily responsible for settling his trades, profits and losses. So whenever he places a trade he will never be able to place a trade where the loss was greater then his account balance because Robinhood has no interest in covering his losses.
Two: So Robinhood automatically freezes the amount of cash equal to the maximal loss of any trade, and 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 be able to place a trade causing a $750,000 dollar loss and this 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 creates an initially frightening debit. But settlement erases it. But that 24 hours your waiting to settle part two of the trade is nerve wracking, even if you understand what’s happening, sadly he may not have understood.
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. And each trying each variation allows an option trader to find the strategy that he/she is good at and truly find their best or favorite trading strategy.
The death of an options trader: understanding in the money put spread exercise procedures properly.
