After watching an hour long interview with Karen Bruton the “Supertrader” on tastytrade.com it is apparent that even seasoned professionals can find it very difficult to determine the legitimacy of a fellow trader. Karen Bruton, founder of Hope Advisors Inc. received a Complaint from the SEC on Tuesday which involved deceptive trade practices amongst numerous other offenses. Essentially, although she preached success in a very public manner (see the video link above), the Fund suffered some very substantial losses, which while would have been recognized by most Fund Managers, were covered up by pushing losses forward without recognizing them. In the meantime, according to the complaint, she received significant compensation for the supposed performance of the fund.
While Ms. Bruton certainly had a significant understanding of the Options Market, like many Options Traders, she had some flaws to her Options Analysis. One key point in her discussion that was a concern of mine was that she didn’t look at Delta (Delta is the movement of the Option Price as a Percentage of the movement of the underlying). I’ve been involved in Options for thirty years and was Head of Risk Management at ICE Futures for seven years, but no one I’ve dealt with who was a successful Options Trader has ever said that they don’t follow Delta. This would be a significant red flag for any member of the risk management community. Although later in the interview, she did recognize that if the out-of-the money options she sold became in the money options, she would be concerned.
Fraud occurs in crazy ways. Sometimes people get involved in a situation that becomes impossible to control. For Options Sellers this has happened in Futures Contracts numerous times. Years ago, a Clearing Member called Volume Investors went out of business due to customers selling too many Call Options. Gold rallied and a multitude of customers blew out. A similar situation occurred in Cotton in 2008 and Sugar the same year. In no case, however, was fraud involved.
As the SEC and CFTC, who has already fined the Hedge Fund, delve into the details of the allegations it will become clear whether the “Supertrader” just got in trouble or was perpetuating a fraud from the outset. Whatever the case may be, when someone says they never pay attention to Delta, and are just concerned about making money, questions should be asked. I am happy to say that I had never heard of Karen Bruton, but like all of the risk management disasters I’ve seen including Amaranth, Refco, MF Global, Volume Investors, Klein Commoditiesand of course Bernie Madoff, there is much to be learned from events like these.
As I reviewed the interview on Tasty Trade, there are definitely indications of what I would consider potentially reckless trading behavior. According to Ms. Bruton’s discussion there were several other traders working with her. I would be very concerned if I was one of those traders and hadn’t already struck some kind of deal with either the SEC or the CFTC. Typically tastytrade.com is an impressive group of traders and analysts (Tom Sosnoff orchestrated the development of the ThinkorSwim Trading Platform). In retrospect, I’m sure they wish they had asked a few more compelling risk management questions and perhaps followed it up.
In Ms. Bruton’s interview she emphasizes the importance of Selling Premium (Selling Naked Options). Unfortunately, while she strenuously expresses her belief in her ability to establish position, she does not seem to do her homework on risk management. Selling Options outright without recognizing the risks involved is almost shocking. She does, however, have tremendous confidence and by listening to her, retroactively, it is easy to see how she ended up in a predicament of enormous losses. It is likely that these substantial losses may have caused her to respond with deceptive trading practices. She may have made a common trading error, selling options and being unable to manage the losses. That’s my guess. To me it seems likely that she kept rolling her position hoping that eventually she would produce enough gains to cover the losses. At that point, the SEC came knocking.
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