On Thursday, I made a mistake that almost cost me more than 25% of my brokerage account.
I’m almost too embarrassed to tell you about it. As Jeff’s editor for over three years, I should’ve known better.
But it stands as an important lesson for anyone getting started with option trading – especially in this market. And it shows just how easily one absentminded move can get the everyday investor in serious trouble…
Here’s how it went down…
I’m sure you’re aware of the utter carnage that erupted in the stock market on Thursday. After opening over 2% lower from Wednesday’s close, the S&P 500 fell nearly 4% more by the end of the day.
The CBOE Volatility Index – which measures the level of uncertainty investors have about the near-term future of the market – spiked over 50% from the previous session. Safe to say, volatility was back in a big way.
I subscribe to Jeff’s view that despite the market’s unbelievable 45% recovery from the March lows, this was just a bear market rally. Stocks would turn down again, and the move would be fierce.
When I saw that play out Thursday, I decided it was time to get aggressive. If the next move lower would indeed take us past the bottom in March, as Jeff predicted, betting on an increase in volatility seemed like a smart move.
So, I decided to buy call options on the ProShares Ultra VIX Short-Term Futures ETF (UVXY). This exchange-traded fund (ETF) moves 3 points for every 1-point move higher or lower in the VIX. Amplify that with the power of a call option, and you could be looking at serious returns…
The only thing left to do was to find the right option. And that’s where I made my fatal error.
You see, while I was looking through the UVXY option chain, I came across something strange. The UVXY September 18 $115 call option had a “bid” price of just $0.12 – meaning that was the lowest price folks were willing to pay to buy that option. That was compared to bids in the range of $2-8 for the options at nearby strike prices.
That’s when my “lizard brain” started talking. “Someone messed up here, and these options are ridiculously cheap. I could easily be looking at 1,000% returns, maybe even by the end of the day…”
I placed the order with a smirk, barely even thinking. I’d found some glitch in the system that was going to make me rich. I had to act fast, or miss out.
Then I looked at my portfolio screen and saw my order was filled at $4.50 per contract – with the option currently trading for about $2.25.
In other words, I was immediately 50% in the hole on a trade that was 37 times larger than I’d intended.
Big problem.
Now, two important things happened here that I want to ensure never happen to you…
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In an effort to snatch that opportunity as fast as I could, I put in a “market order” for the option.
Before I go on, let me be clear: NEVER put in a market order for an option trade. It almost always results in paying too much for the option – with my case being an extreme example.
You see, when markets are volatile, the “spread” between bid and ask prices – the latter of which shows the minimum amount an option seller is willing to accept – becomes very wide. This effect is even more extreme on securities that track volatility, like UVXY.
When you enter a market order on an option, the market maker who oversees the transaction can sell you the option for somewhere between the bid and ask prices.
But in this case, with volatility so high and trading such an inherently volatile security, they happened to sell me the option for nearly twice the “ask” price, which is how I wound up opening the trade with an automatic 50% loss.
This all could have been avoided with a “limit order” – which would only execute at the price I specify. I likely never would’ve been able to buy that option for $0.12. But, a limit order would’ve kept me out of that terrible situation entirely.
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A classic case of FOMO (fear of missing out).
When FOMO hits, traders abandon their sense. They discount the principles they’ve learned and take the process for granted. And, more often than not, trades made while under the influence of FOMO come back to bite.
That’s exactly what happened to me. All I saw were dollar signs, and my normally careful process was chucked out the window.
I was in deep trouble. Either I could cut my losses and learn the hard lesson, or hold on in hopes of just breaking even if the option doubled.
But, something told me to call my brokerage and see if anything could be done. After all, I was filled at twice the ask price of the option. It was abnormal, even with volatility as high as it was.
In fact, the rep I talked to said that it looked like Bernie Madoff had filled my order. And that my chances of getting out of the trade were slim to none.
Now, I don’t know why the market maker was in such a good mood on Thursday. But, by some miracle, they busted they trade. It was like it never happened.
When I got that confirmation call, I just about jumped through my ceiling. I was facing thousands of dollars in losses due to my own hubris, and some kind soul let me go with just a slap on the wrist.
But, the reason why I’m telling you all of this is to show you how to avoid getting into that situation.
Recognizing when you’re experiencing a bad bout of FOMO, and knowing to never place an option trade with a market order, are the two most important things to keep in mind.
Best regards,
Mike Merson
Managing Editor, Market Minute
P.S. Jeff Clark has made it his mission to show everyday folks how to trade options safely and profitably – without paying an arm and a leg to get started.
And, he’s achieved that goal with his introductory advisory Jeff Clark Trader. For just $19, you’ll have access to a wealth of training resources – alongside monthly options recommendations – from someone who retired 25 years early by trading them.
With markets as volatile as they are, there’s never been a better time to get started. Click here to learn more.
Reader Mailbag
In today’s mailbag, a few readers thank Jeff for his recent trade recommendations…
This was a great trade. I took your advice from many of the other trades and I put a sell to close order on the trade when it hit a 100% gain at $3.50. It sold this morning as soon as the market opened for that price, and then I received your alert to sell right after. Thanks for your mostly great picks. I’m learning a lot about the market and I’m having fun. I think I made a little over 100% on this trade.
On a side note, when we lost on the TUP options trade, I was a bit disappointed. However, your research and information said it was a really great company, and so, I decided to buy TUP close to its bottom after the crash. Not only have I recuperated the losses from the options trade, but I’m starting to make money on the stock. I think I calculated the breakeven amount around $4.50.
I just want to thank you again for your research. It’s sound, and just the right amount, so I’m not overwhelmed with too much information. I look forward to joining your Protégé Program (hopefully) when I’m retired and no longer a full-time employee. I hope your recommendations will help make that happen sooner.
– Julie
Jeff, I invested in The Breakout Alert and went all-in with a lifetime membership. I’d never heard of Jeff Clark, so I did my research. I read the good, the bad, and ugly reviews. I was satisfied that you are the real deal.
In less than a week, the investments you recommended were up 7% with several still in the buying range. If I sold, I would recover my membership fee. I’m excited to see where this goes, and to hear of more opportunities
to invest.I also want to give a shout out to your customer service team. They are responsive, informative, and very professional. Please pass on my thanks.
– Richard
And subscriber Michael reflects on Jeff’s recent Market Minute essay…
Thanks for this, Jeff! Very timely. I had one option contract on a few trades, but couldn’t afford to buy two of each as you had suggested. So, having just one contract I struggled on deciding when to sell. It was either when each of them hit 50%, or keep them for a better profit.
I chose to sell at 50%. Your essay now makes me feel so much better. How can I argue with a 50% return on investment? I’ll continue to take these returns until I have enough extra capital to buy two contracts. I’ll sell one at 50% and let the other one ride. Thanks.
– Michael
Thank you, as always, for your thoughtful comments. We look forward to reading them every day. Keep them coming at [email protected].