OptionSellers.com and the naked natural-gas options

A steady income strategy

OptionSellers.com was a small money-management firm based in Tampa, Florida, founded by James Cordier in 1999. Its strategy had a name: FUDOM, short for Fundamentals combined with Deep Out-of-the-Money options. In practice this meant selling naked, uncovered options on physical commodities including natural gas, crude oil, gold and grains, at strike prices far from where the market was trading. Most months, the market never got close to the strike, the option expired worthless, and the firm kept the premium as income for its clients. By 2018 this approach had attracted about $150 million across roughly 290 client accounts, most of them high-net-worth individuals looking for steady returns.

A tight market before winter

Natural gas is a market traders nickname the widow-maker, because it can move sharply on a single weather forecast. Entering November 2018, US natural gas storage was unusually low, reported at around 16 to 19% below its five-year average, the tightest position in years. Those conditions were primed for a squeeze if cold weather arrived, and it did. On 14 November 2018 the NYMEX December natural gas future settled up about 18% at roughly $4.837 per million British thermal units (MMBtu), having traded as much as 20% higher intraday. It was the sharpest one-day jump in about four years.

The spike meets the short calls

That move ran straight through OptionSellers.com's short call positions. The clearing broker, INTL FCStone, had already begun liquidating client accounts on 13 November as the positions came under pressure, and the spike the next day made things much worse. On 15 November, the firm emailed its clients a notice titled "Catastrophic Loss Event," telling them that the natural-gas position had "overran our risk control systems and left us at the mercy of the market... it was a rogue wave and it overwhelmed us." For many of the roughly 290 accounts, the loss was not confined to their invested capital. Because the accounts had been carrying naked short calls with no cap on the possible loss, several clients ended up owing money back to the broker once their positions were closed out. INTL FCStone later stated, in a filing reported by Bloomberg on 29 November 2018, that former client accounts collectively owed it $35.3 million, net of amounts already collected, with no single account owing more than $1.4 million.

The apology and the aftermath

On 16 November 2018, Cordier posted a roughly ten-minute video to YouTube, apologising to clients individually and describing the episode as "a rogue wave that I was unable to navigate," adding that it had "likely cost me my hedge fund." The video was viewed more than 500,000 times and drew wide coverage in the financial press. The firm closed within days of the spike. Former clients and their lawyers went on to file arbitration claims and lawsuits against Cordier and against INTL FCStone, alleging that the strategy had been unsuitable for the clients it was sold to and that the firm's risk controls had been inadequate.

Background

The trade looked safe for years for a reason rooted in the option writer's side of the market. A trader who buys a call option pays a premium upfront, and that premium is the most they can ever lose. If the underlying price never reaches the strike, the option expires worthless and the buyer's loss is the premium, nothing more. The other side of that same trade works differently. The writer (seller) of that call receives the premium upfront, and if the option expires worthless, the writer keeps it as pure income. This is what makes writing deep out-of-the-money options look attractive: the trade "wins" almost every time, and the win rate can run for years without a loss.

The rare occasion on which the underlying does reach the strike changes the picture entirely. A bought call's gain is unbounded, because there is no ceiling on how high a price can rise. The writer's loss on that same call is therefore also unbounded, in the opposite direction, capped only by how high the underlying goes. OptionSellers.com's clients had not bought any offsetting position in the underlying commodity or futures contract, so in course language they were naked writers: their maximum gain was fixed at the premium collected, but their maximum loss had no ceiling at all.

Mechanics in course language

Lecture 9 draws the distinction between the holder of an option, whose maximum loss is the premium paid, and the writer, whose obligation the clearing house enforces in cash, regardless of how large it grows. The instrument here is a listed, exchange-traded option on a physical commodity futures contract, specifically short (written) calls on NYMEX natural gas futures, and it sits squarely in that distinction.

Selling deep out-of-the-money calls collects a small premium, and most of the time the option simply expires worthless, so the premium is pure income. The payoff shape is the whole story here. A long call's loss is bounded below, at the premium paid, and its gain is unbounded above. A short (naked) call is the mirror image: its gain is bounded above, at the premium received, and its loss is unbounded above, because there is no ceiling on how high the underlying price can rise. Natural gas is a market where that ceiling genuinely does not exist in practice. A cold snap against a backdrop of low storage can push prices up by double-digit percentages in a single session, which is exactly what happened on 14 November 2018.

What turned a trading loss into a client debt was margin, and the mechanism is precise. As the short calls moved deep in the money, their mark-to-market losses exceeded the collateral the clearing broker held against the accounts. Because losses on a naked call are theoretically unlimited, margin cannot cap them; it only determines how much collateral a broker holds at any moment and how much extra it can demand before it has to liquidate a position to protect itself. When INTL FCStone liquidated the accounts into a fast, moving market from 13 November onward, several accounts ended up owing more than their entire posted equity. A high-probability income strategy turned into a debt obligation almost overnight.