Lamentations of a Put Seller

I spent my entire adulthood in the derivative markets – making my first retail options trade at 18 and my first professional trade at 21. For more than 25 years, I gained proficiency in triplicate with long stints as a firm trader (trading other people’s money), proprietary trader (risking my own capital) and, a period where I hired others to trade on my behalf.

Throughout my lumpy career, I was directly impacted by and responded to: Crashes, melt-ups, takeovers, droughts, invasions, currency contagions, etc. Those decades of personal feast or famine cloaked me with a fallacious sense of discernment blended with an unusual air of self-confidence – classic symptoms of a war-torn trader who had been a first-hand witness of every plausible market combination.

One of my biggest trading lessons started in late autumn 2007.

For eight years, I was a proud shareholder of the large insurance concern – AIG (NYSE:AIG). Throughout that time, I was steadfast and unmovable in my devotion as a stockholder. And, my affection grew ever fonder as the company nearly scuttled through 9/11 and shook violently during the 2005 loss of its coveted AAA government credit rating. That tumultuous eight-year affair had cost me $20.00 per share as the stock seeped lower with each passing year.

Yet, I was infatuated with the company, hypnotized with its potential, and star-struck with my own personal trading resume. With every tick lower in AIG stock, I twisted yet another fantasy on why everyone else had it wrong. I had Stockholm syndrome to the nth degree. And, I set out to prove myself right and everyone else wrong!

Impulsive Actions Lead to Undesirable Consequences

“Stand up and be counted!”  “Consensus is wrong!”  “The market is over-emphasizing its AAA rating!”  With that mindset, I produced a plan. I was going to sell puts naked on AIG and either:

•  Best case scenario – Watch AIG stock rally (which I was fully expecting) and enjoy seeing my short puts expire worthless providing me with a little extra income!
• Worst case scenario – AIG stock expires beneath my short put strike in which case I would be “put” the stock (i.e. buy the stock) at the puts strike price. If I liked the stock at $80.00 (original purchase price) I will love it at $55.00!  That best describes the boldness of my approach.

The downward spiral started in late October 2007; I sold 10 December $55.00 puts for $2.00 with AIG trading at $58.00. My profit and loss details were as follows:

Trade #1: Sold 10 AIG December ’07 $55.00 puts at $2.00 per share. AIG reference: $58.00

• Best case scenario -If at expiration AIG closed $55.01 or higher – I would keep the entire $2,000. (Recall, I sold 10 puts at $2.00. This equates to 10 x 100 shares x $2.00 premium = $2,000).
• Break-even scenario – If at expiration AIG closed at $53.00. (Recall, I sold the $55.00 put for $2.00. $55.00 strike price - $2.00 premium = $53.00). I would be “put” stock at $55.00 however, my theoretical purchase price would be $53.00 given the premium I received for selling the put.
• Worst case scenario – If at expiration AIG closed at $53.00 or lower, my loss would be 1:1 with the downward stock move. 

In short, if AIG settled at $55.00 or below, I would be assigned the stock (i.e. I would own 1,000 shares at $55.00 however, given the original $2.00 premium I received, I would be insulated from loss until the stock went below $53.00).

December expiration day arrived with AIG stock expiring at $58.00. My account grew by $2,000 due to my put sale expiring worthless. Feeling justified in my conviction, I repeated the same strategy. This time around, I sold the February ‘08 $55.00 put at $2.50 per share ($2.50 x 100 shares x10 contracts = $2,500) with AIG stock trading near $58.00.

Trade #2: Sold 10 AIG February ‘08 $55.00 puts @ $2.50 per share. AIG reference: $58.00

• Best case scenario -If at expiration AIG closed $55.01 or higher – I would keep the entire $2,500. (Recall, I sold 10 puts at $2.50. This equates to 10 x 100 shares x $2.50 premium = $2,500).
• Break-even scenario – If at expiration AIG closed at $52.50. (Recall, I sold the $55.00 put for $2.50. $55.00 strike price - $2.50 premium = $52.50). I would be “put” stock at $55.00 however, my theoretical purchase price would be $52.50 given the premium I received for selling the put.
• Worst case scenario – If at expiration AIG closed at $52.50 or lower, my loss would be 1:1 with the downward stock move. 

This is when things went horribly wrong! AIG stock expired in February ‘08 at $47.00 – leaving me straddled somewhere between dumbstruck and shell-shocked!  “How could’ve I possibly allowed myself to lose $5,500 on top of what I was already losing on my original stock investment!”  “Where was the discipline, the stop-loss mechanisms, the exit plan?”

In a random flash of awareness, I recognized I had no plan and, if I did, it was stubbornness peppered with stupidity. I distinctly recall feeling captured in a frozen, hypnotic state likened to a nightmare - one where you’re desperately attempting to run from danger yet, you simply cannot move your legs. No matter what, I was now the proud owner of 1,000 additional shares of AIG at $52.50; (I was assigned on the $55.00 put strike that I sold price minus $2.50 premium collected).

In March ’08 my near ten-year affair came to an abrupt end. My love had turned to sadness then to anger as I finally came to terms with my laundry list of short-comings. I finally jettisoned my stock at $43.00 per share having lost a small fortune and never looked back. I was attending an MLB game on a hot July day when a fellow ex-trader friend of mine texted me that AIG stock had fallen below $25.00. Another friend contacted me in September ’08 – he was still long AIG stock and it had fallen to $3.00. He mentioned he stopped looking at his stock account statements; allowing the unopened envelopes to pile up in a corner provided him with solace – an act of defiance.

The Suit Always Tears at the Seam

Put selling is not necessarily a bad strategy nor is losing money. There are strategies for every season and, there is no better instructor than the burn of being wrong. The single best teacher of sound risk-management is always experience. But, what went wrong?  First, I had a failure of imagination. I simply never imagined that, with all the randomness surrounding us that the threat to AIG stock was coming from a place elsewhere than I supposed. Another mistake was I was going on pre-fixed ideas. I was basing my decision on admiration for the company and outcome combinations yet, had no idea where the lock was.

My point is that allowing oneself to be lulled into a false sense of security, making facile assumptions – complacency, in a word – is one of the greatest enemies of options trading and sound risk-management practices. And, it is particularly threatening when a long time has elapsed between painful lessons. A sound options strategy looks at the seams – the in-between places; these are the soft points and ones where we are most vulnerable. To be successful, one needs to play defense and offense at the same time. Always vigilant, always retraining, always rethinking, always staying fresh.