August 13, 2017
Commodity Trading Disaster and Triumph
The subject here is a series of events I experienced early in my career as a commodity broker (1980-1984) that I believe are quite relevant to the present…and if not, will at least maybe make for a interesting read…or maybe not. Whatever the case, here it is…
In the spring of 1984, after several years as a commodity broker, I was still very much of a rookie in the Merrill Lynch Commodities office on the 19th floor of the 1st Atlanta Building in downtown Atlanta. The office, which took up half of that floor, had maybe 15 brokers, with just about as many people in support, and was still very much as wildly active as it had been when I started work there in August, 1980 (midst a drought and at the very top of the commodity markets for something like the next 20 years). I had been hired as a “shadow” to one of the more successful brokers in the office, with my primary responsibility being to prospect for him while learning the business. I handled the job relatively well, and about a year later, I asked for and was given the chance to try my own hand as a broker and trader, the result being that after then completing a month of classroom training with Merrill’s “experts” in New York and Chicago, I officially became a broker in September, 1981.
After a moderately quiet first full year in 1982 spent building my “book” as a new broker, in April of 1983 I experienced my first absolute disaster in the business…when gold dropped from $500 to $400 in 5 days, which was then a MASSIVE move and especially quite destructive in that there were no options at that time, only margined futures, meaning that the risk statement, “You can lose more than you invest”, was exactly what happened to a number of my clients…All of them were bullish, and long futures (as was the whole world) and when you consider that the margin per contract was about $2500, and then realize that the $100 one week drop represented a $10,000 per contact move (against them), the simple math was that a $2500 investment could have put you $7500 in the hole (owed to Merrill Lynch)…So it got pretty nasty, and my hands were literally shaking while on the phone with a few of them who were severely underwater on the last day of the move…when Gold had opened $40 lower. Every account I had lost every dollar they had invested…and then some…It was horrendous…to the extent that the next morning, after all the financial dust had settled, I headed for Florida to visit (or hide out) with my parents, and 95% of the opinion I should find a new profession.
Here is what that one week move looked like…
Again, this was GIANT move…I went from comfortably believing a big score was right in front of me…to blown out of the water in the space of 5 days.
However, by the time I arrived in St. Pete, after 9 hours of driving, and thinking behind the wheel, I had decided that I would make some changes to how I approached risk management and trading (one being that I would be forever wary of popular opinions) and give it another try…So, I arrived back in Atlanta the following Monday with a brand new perspective, and amazingly, the very first idea I came up with…a diversified strategy of buying Corn, Wheat, Soybeans and Live Hogs in equal quantities using “mini” futures contracts (all 4 markets were “hated” by analysts)…astoundingly produced 500%+ gains in less than two months, thus becoming the first truly successful major trade of my career…To be honest, I did have the benefit of a drought that summer, but believe me, you don’t just snap your fingers and scoop up the money when a big, dynamic move like that is taking place. Every day is nerve-racking. Every up day has you fearing that tomorrow it all ends and you could “give it all back”, not to mention that you DO get some rain in places during a drought, meaning that here ARE days when drought markets open and/or close sharply lower, or that you DO have to nervously add on the way up if you really want to score…And finally, to cap it all off successfully, you DO have to walk away when the market still feels like it’s rocketing…It truly is an exhausting psychological experience but I did make it all happen (I later screwed up again)…the result being that, in the space of 4 months, I had seen about the worst and best of what you could ever expect in the markets as a broker and trader.
Here is a look at that little experience…
That was 1983, which brings me up to 1984, which is what I really wanted to reference here…
When I entered the business in 1980, there were no options on futures contracts…But about 1982, they did begin to introduce them, as I remember, starting with options on the S&P 500, then Gold, and then in the Treasury Bond market. I may have the order in which they appeared wrong, but the point is, they were a totally new way to approach the markets…And most importantly, if you were an options buyer, they allowed you to precisely define how much you wanted to risk, while at the same time offering, I believe, more leverage than you could ever achieve using straight up futures contracts (and the margin dangers that go with them). Interestingly however, in early 1984, options had therefore been around for a few years but not a single broker in that big Merrill office had ever done even the first option trade, the mentality then being something like, “Options are for sissies. Real men trade Futures.” Really, that was the attitude, and nobody, myself included, knew anything about them.
In March, 1984, Merrill Lynch Commodities announced a 6 week long, New Accounts Contest for all of its commodity brokers, with cash or luxury trip prizes to be awarded to the top account openers in the country. Ever the contrarian I suppose, I personally thought the whole thing was a bad idea, suspecting that it was entirely possible this sort of competition might inspire some brokers to make misleading claims regarding potential large profits to prospects…or even lead some brokers to encourage people who shouldn’t be trading at all to open accounts. I therefore ignored the rah-rah roll out from the company and went on with my normal research towards finding what I thought could be the next big trade on the board…the result being that a few weeks later I was sure I had found it: Buying the Treasury Bond market…AND while trying to figure out how to take the position, I quickly realized that the best way to do it was with these never-before-used, and strangely named, “call options.”
The Bond market had come down about 12 points during the preceding year and was sitting around the 66 level. I was “certain” that at least a 15-20 point rally was coming, and furthermore, that it would start with some sort of brisk 6-7 point surge during the first month or two of the rally. So this is what I saw…and what I believed the opportunity to be:
When I grasped that an investor could put his money on the table through buying an option with LIMITED RISK, and then have what was an honest shot at making 3-6 times their investment (or even more), it lit a fire under me. I did have a VERY strong opinion that Bonds were ready to rally hard, then and there, and immediately started selling this idea day and night to everyone I could for the next three weeks, even going so far as meeting one guy at 2:00 AM at a town square in the boondocks of northwest Florida…and then followed that by jumping on a plane for Dallas, Texas the very next day, where I was introduced to a big investor in an extremely upscale restaurant, and pitched him on buying $250,000 worth of these calls across the dinner table (little did I know he was going bankrupt and couldn’t have done it if he wanted to). I don’t remember how many accounts I opened during those last three weeks of the contest, which I had really only entered by default, but it was enough to come in second in the country, not because I wanted to win…but simply because I believed I had a BIG winner using this new options vehicle with its limited risk. In fact, I was so sure of the outcome that I borrowed $10,000 (never smart) and put the trade on for myself…
To fully put all this in perspective, you must understand that I was selling an idea that EVERYBODY thought was nuts. My bet was that interest rates would be going lower, and without presenting all of the headlines and groupthink that was out there at the time, I can tell you that the media was 100% jammed with “logic” that argued for exactly the opposite of what I was thinking…but I was so enthusiastic, and because I was able to present my own case as to why I thought I was right, most of the people who bought my idea did so just based on their trust in my judgment…such that one of them, actually my oldest and very first commodity account, told me, “I think you are G.D. wrong but you are so strong on this that I am going to do it.”
However, in spite of my strong convictions, I still told every one of my buyers that, “If this doesn’t work, you have got to do it again. As a function of the leverage in these options, if I am wrong on my timing, the trade will still be there…and with stronger odds I think…and the same leverage…two months from now. So, really, if we are wrong, you have GOT to do it again.” To a man, I made them agree to that as they plunked down their cash…
All told, I raised about $400,000 during those three weeks and bought something like 1300 of the June 70 calls…Then, as the contest ended, I figured I had enough and sat back to see the bond market take off…
BUT…I was wrong…In fact, literally the day I stopped buying, with Bonds at their highest point since I had started my campaign…and looking like they were about to lift off…they started going down…and did this:
Yep. The day I stopped buying, with the market on three week highs and looking it was ready to go, it started straight down and did nothing else but that for the next 6 weeks. In the beginning of the descent, I kept up my hopes as I’d seen any number of markets look one way…and then reverse hard and take off…AND also because I just “knew” I was going to be right sooner (I hoped) or later…but this was not to be case (yet), and on the day all those options officially expired worthless at 3:00 PM late in May, with no pride whatsoever, I openly sat at my desk in the middle of the whole office and cried…I then headed for the house, stopped at a liquor store on the way there, bought a bottle of scotch and proceeded to drink myself into a blind stupor. To say I was devastated does not even come close to describing how miserable I felt.
After a few days, only because duty required it as a Merrill Lynch employee, I returned to the office, pretty much a walking zombie…once again thinking, “I gotta get out of this business”…But at the same time I was stubbornly certain that the trade was still there, more so than before really…but frankly I just didn’t have the stomach to take it on again…I was pulp…and had zero desire to tell anybody, “Hey. Guess what I think?”, and meanwhile, although it no longer mattered, Bonds were still making new lows as I spent my time in the office staring into space.
A week or two went by with me moping through every day, until finally, sitting in the steam room after some scrappy raquetball in the downtown YMCA, , the big broker who had originally hired me to work as his shadow, and was now the office manager, shook me out of my coma by saying: “I think you are totally, totally wrong about the bond market. I couldn’t disagree more, but YOU still think it is going up, and somehow YOU have got to pick your ass up and get all of those people back in it…with something.” And, as this had been my game plan to begin with, and even though I had been 150% sure it would become unnecessary, he kicked me enough such that the next day I had revived my spirits and vigorously started working on everyone to buy Treasury Bond calls again…Understandably, I did NOT get any enthusiastic reception but my pleading (and pushing) did allow me to get almost 100% of those people back on, although not a single one of them came back with anything close to the size of their original investment…which they “should” have…but I DID get them bck on with something…and here is the sequence of events that then followed…
As Bonds had been declining (and rates rising) the Stock Market had also been coming off for the first 7 months of 1984…and in the same way that no one thought Bonds could rally, NO ONE thought stocks were a buy either…to the very real extent that when I phoned the S&P floor to buy S&P calls, I heard the phone clerk yell my order out to a very quiet pit, and then heard an answering roar from all the pit brokers, which was followed by my phone guy actually LAUGHING at what I was doing, and telling me, “Buddy, you can buy all of those you want. Everybody in the pit will sell them to you.” In other words, I was buying when NOBODY else was, and as it worked out, my timing could not have been any better/luckier than it was…Here is what happened in that market…
So to recount, I once again had experienced a monumental disaster…and then, within several months, had hit it just as monumentally big…Because of, as always, some luck, but also because I stuck with the approach…and the plan…and that I never, ever forget that futures options do give you more leverage than any other financial vehicle on this planet…and while that leverage can definitley burn you, it can just as definitely do the opposite. BUT YOU HAVE TO STAY IN THE GAME.
And even though I’m recounting experiences from the earliest days of my career, which is almost ancient history, I can assure you I have been through the same cycle on many more occasions, as, quite simply, losing and winning ARE what this game is about, which long ago prompted me to put two signs on the wall in front of me (which I have referenced here many times):
YOU WILL BE WRONG. YOU WILL BE RIGHT.
ONE GOOD TRADE IS ALL IT TAKES.
And I swear by both of those statements. I am going to be wrong at times, either just TOTALLY backwards or just off in my timing…both of which mean LOSING…But I also have proven over and over and over again that I do get it right as well…and when I do, with power and leverage of options, “One good trade” CAN result in some big, big numbers…
SO, NOW TO THE PRESENT…WHAT HAPPENS NEXT?
Okay…The Eurodollar trade started out beautifully last fall, but has turned into a bust since mid-March, with tons of September puts now having very strong odds of expiring worthless, no differently than was the case with those Treasury Bond calls in 1984…And while there is nothing that suggests that what comes next is a gloriously profitable outcome, all I can say, FROM EXPERIENCE, is that this HAS happened with me far too many times to count…the REAL point being, that it DOES happen in this business…but to make the NEXT hit, there are times when you DO have to forget the previously quite painful losses and spend the money on the next trade. These ARE highly leveraged markets, and just as you can lose big, you CAN win big, but to do so, you DO have to be in the market to have it happen…even when you maybe just HATE the idea.
And that, my friend, IS where we are with Eurodollars…The move DID start…but then paused…Rates ARE heading higher…and my VERY strong opinion is that 3-6 or 9 months from now I will be looking back and seeing a relatively straight down, large, NON-STOP move in this market…And right now is NOT the time to be out of this trade. Quite the contrary, Eurodollars having been sideways to higher for MONTHS now, and with put options having been slashed in price to truly unbelievable levels, NOW is the time to be repositioning out into 2018. I understand it, but now is NOT the time to be licking your wounds….OR buying into the “logic” that is everywhere now…that “rates don’t need to go up much, or soon, from here.”
Yes, I know there are people out there thinking, “broken record”, or “Why is he still saying the same thing?”, and “I ain’t doing any more of that”, but like I’ve said, I HAVE been here before. I KNOW what it means when there is NO ONE who wants to get back on the horse. I understand it. But I also know that, in this sh*t, it’s amazing, but the best trades are FREQUENTLY the ones that you least want to do.
Interest Rates ARE going up. And I still say they are going up faster than the markets are even close to reflecting what WILL become the reality in rates.
As a final note before my specific recommendation, I will say that I think the Korean story is just the next “Brexit”, or the next “reason” being spouted by all the Wall Street “geniuses” to be wary of buying stocks…And I continue to disagree with them. I STILL think the stock market, and the economy, are in nothing short of a lift off phase to the upside…thus representing PART of my rationale for expecting rates to move sharply higher as we go forward, literally, from right here…RIGHT NOW.
Here is the trade…
WHAT YOU SEE BELOW IS THAT THE EURODOLLAR MARKET CURRENTLY ONLY “EXPECTS” ONE 1/4 PERCENT INCREASE IN RATES BETWEEN NOW AND NEXT SUMMER. I THINK RATES WILL RISE AT LEAST 3/4 PERCENT BETWEEN NOW AND THEN…AND THEREFORE LOOK TO SEE THIS JUNE, 2018, CONTRACT TRADE DOWN, AT LEAST, TO THE 9775 AREA.
And here’s a little further perspective as to where this market might go…
That’s it…Like I said, this does not have to work out as it finally did with that 1984 Bond trade, but that IS what I am looking for…and precisely why I personally am not backing off from further purchases of puts here. I CONTINUE TO THINK THIS IS A MONSTER TRADE…AND THAT IT IS NOW READY TO MOVE AGAIN.
Give me a ring if you want to talk about it.
All option prices in this newsletter include all fees and commissions.
The author of this piece currently trades for his own account and has a financial interest in the following derivative products mentioned within: Eurodollars