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Back in 1997 or 1998, my market-making firm on the Pacific Options Exchange was in search of a trader to run the LMM (Lead Market Maker, or specialist post) on the floor of the exchange.

The firm settled on Alex, who was a veteran trader from Chicago and spent most of his career trading options on old-economy stocks such as Procter and Gamble (PG) and American Express (AXP). This was about the time that the internet bubble was starting to inflate, and our man Alex was wholly unprepared to be trading internet stocks.

Alex was a former professional football player—he played for the Chicago Bears. A deeply religious mountain of a man, he began every day by doing 500 push-ups and 500 sit-ups and praying for 15 minutes. The dude was ripped. 

The LMM was responsible for making markets in options on 52 different stocks; one of them was Yahoo. So, Alex settles into his role as the LMM, and before long, customers are lifting him out of his shoes on options. They’re buying straddles and strangles, and Alex just keeps on selling them because his years of trading PG and AXP taught him that options don’t typically go into exercise. He’s short gamma out the wazoo.

Yahoo earnings end up being the day before expiration. Yahoo is trading at $40. The numbers are released, and the stock goes to $140. Up a hundred bucks. Alex looks at the screen—he’s down tens of millions of dollars. This is catastrophic. This will blow up the firm. This will blow up the clearing firm.

Alex drops to his knees in the middle of the crowd on the trading floor and begins to pray. Right in front of everyone.

The stock holds at $140 for a minute, then begins dropping. $130. $120. $110. Alex continues to pray.

The stock goes all the way back to $40. Alex quits his job the next day.

Trading Options Is No Joke

Still want to trade options? You can lose a lot of money trading them. You can get carried out trading options. The story I just told illustrates the dangers of selling too many options. You can also buy too many options. You can get carried out doing that, too, though it won’t be as dramatic. You will bleed to death slowly.

I remember being a young clerk standing by one of the booths, overhearing a conversation between two traders about a stock that dropped 50% in one day. Apparently, one of the traders blew up on that. “You just cannot be front spread in this environment,” they said. Meaning, the only way to stay alive was to buy options.

Then came the vol crush a couple years later. Stocks stopped moving around. Customers were selling tens and hundreds of thousands of options, crushing volatility, and the market makers couldn’t get out of the way.

You think you want to trade options? It will be the hardest thing you ever do.

Not to say that you can’t get lucky here and there on a trade. I bought some Apple (AAPL) puts a couple months ago, perfectly timed the entry, perfectly timed the exit, and made some money. It was the kind of trade you dream of. Doesn’t happen very often. With options trading, it is not enough to be right on direction—you must also be right on time. Most people don’t get this. If XYZ is trading at $40 and you buy the June $50 calls, it doesn’t help if XYZ goes to $60 in July. You gotta get the timing and direction right.

“Fine,” you say, “I will just buy long-term options.” Then implied vol goes down 10 clicks, you lose half your money, and the stock hasn’t even moved.

Or some broker tells you to buy iron condors on the index in 2018 and the market goes down 20% in a month.

Or you buy some calls on a stock, and after six months, it hasn’t moved, so you sell the calls to get whatever you can for them. Then, a week later, the company is acquired.

There are a million ways to lose money trading options. At least if you take my Options Masterclass, you will know how and why you are losing it.

Gallows Humor

Yes, that is options gallows humor.

To trade stock, you only have to think in two dimensions. Stock up, stock down. Easy enough. 

With options, you have to think in five dimensions, like the bulk beings in Interstellar. Only for the mathematically inclined. Yes, it’s hard. Yes, hard things are worth doing. Yes, I try to make it as easy and understandable as possible, using some case studies and lessons along the way.

I wrote the Options Masterclass over the course of a few weeks last year. I sent it around to a few options experts—vol fund managers and the like—and it got their seal of approval. It’s factually accurate and entertaining.

Won’t you give it a try?

In the meantime, here’s a free report on options trading lessons from the 2021 GameStop (GME) short squeeze. I also outline the fates of options traders who trade around Netflix (NFLX) and Tesla (TSLA) earnings. Learn more about the goat rodeo here.

Jared Dillian, MFA