Still Thinking About the “Supertrader”? Brexit Provides a Look at the Perils of Short Options.

As disclosed in the Securities Exchange Commissions’ Complaint against Hope Advisors, LLC, and Karen Bruton and Just Hope Foundation “since at least November 2014, Hope and Bruton have engaged in a continuous pattern of fraudulent trading to circumvent the impact of the high-water-mark fee structure”. The key element of the Complaint as far as I’m concerned is“Hope has been using the Scheme Trades to avoid realization of more than $50 million in losses, while still earning large monthly incentive fees”. As a risk manager, the essential element is where did these losses occur and did they provide the environment for the “fraudulent trading” to hide the losses as long as possible.

 

It is pretty easy after the Brexit vote and a tremendous increase in volatility to see how people get into significant trouble with a Short Options Strategy. From Bruton’s own description, that was her methodology of trading. For anyone Short Puts on Friday, it is easy to understand how essential it is to manage and to trade within one’s capital limitations. That is not always easy to understand.

The following factors are clear from the Complaint and having had the opportunity to listen to Bruton when she was interviewed by TastyTrade, an Options Trading Group. Although the interviews have been removed from the internet, most people who followed her were aware of her propensity to sell naked options. Bruton’s main method of trading was to be short initially out-of-the money options in the hope that they would expire worthless. Unfortunately, in times of significant volatility, like we just experience with Brexit, it can be difficult, if not impossible, to manage losses. Without a risk management system to cut losses and the willingness to recognize those losses, I believe that Bruton fell into the trap of trying to hide her losses.

The Complaint clearly describes the following allegation: “For example, in October of 2014, Hope experienced massive trading losses as a result of volatility in the market. The HI Fund and the HDB Fund collectively ended the month with unrealized losses of approximately $100 million, most of which resulted from the October trading losses. Nevertheless, Hope reported to investors that the Funds had millions of dollars’ worth of “realized” gains in October and collected incentive fees of more than $600,000.” The excerpts from the 34 page Complaint paints a relatively clear picture of the allegations. In addition, looking back at the trading activity in the E-mini S&P at the time, it was a very volatile period. At the end of September of 2014 the market closed at 1959.75 and reached a low of 1813.00 in October. This volatility would cause a short options trader significant pain.

As a trader and a former risk manager, it is relatively easy to see how something like this happened. In her interview, it was clear that Bruton’s risk management technique was completely unsophisticated for a trader of her size. The mere mention that she didn’t pay much attention to Delta was enough to engage in a serious risk management discussion. Despite that, even the best traders make serious mistakes and ultimately, as the allegations indicate, she resorted to fraudulent trade practices to hide her losses. It’s the motivation that is most interesting. Was she unwilling to recognize her losses or was she trying to collect additional fees? We may never know the answer; however motivation is what makes understanding a serious digression interesting. It’s easy to lose a lot of money selling options; it’s more difficult to cover it up at the expense of clients. It will be a long time, if ever, before we find out the answer.

Our Options Guide is a PDF available for those interested in trading options. It provides an excellent strategy for reducing risk in the stock market. We offer individual Options Trading Webinars to improve the effectiveness of those who are interested in improving their technique.

Options trading involves significant risk and is not suitable for every investor. The information is obtained from sources believed to be reliable, but is in no way guaranteed. Past results are not indicative of future results. 

 

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