What sort of fund structure can cause clients lose more than 100% losses when the fund blows up?

[nooby_mcnoob]

I think the OP wanted to know how is it possible to lose more than you put in. I think this is how the recent blowup went down:

- Pro thinks asset will never hit price $Y, and sells deep naked OTM calls with a strike of $Y, he hedges 12 of these with 1 purchase of the actual asset at the current price of $X
- Oops, asset hits price $Y+$Z, everone who bought his deep naked OTM calls wants to exercise at price $Y
- Pro has to buy at $Y+$Z and sell at $Y, meaning he loses $Z
- Since the original trade was leveraged, you lose $Z x some factor, which can be greater than your account balance. You then owe this to the clearing house because that's how faith in the market remains. Or something like that.

I do not claim to be correct, this is just my understanding. Happy to be shown where I'm wrong.

Edit: NVM, just wanted to know why the clients are on the hook and not the pro.

 

[Robert Morse]

I thought they stop at disclosing investment can be lost 100%. If they state clearly than more than 100% can be lost, it's fine.

Yes the disclosures are all in place but these are all adults making investingments with eyes wide open. The investor needs to do their own due diligence and make investments that fit their needs and risk. No one should place too much of their savings in risky investments that are highly correlated. If they do, they are gambling with their future.

 

[Robert Morse]

NVM, just wanted to know why the clients are on the hook and not the pro.

Not sure what NVM is but I answered that question. These are SMAs and the investor opens an account in their name or entity. You can sue the manager, which I expect the investors will, but arbitration will take time and you have to show they breached their docs.

 

[Overnight]

Not sure what NVM is but I answered that question. These are SMAs and the investor opens an account in their name or entity. You can sue the manager, which I expect the investors will, but arbitration will take time and you have to show they breached their docs.

NVM in Internet parlance = Never Mind. This is why we (Well, I really) call you OMM. Old Man Morse. You are like so old. Happy T-day Mr. Morse!

 

[userque]

When optionsellers blew up, the clients not only lost 100% of their invested money but owe money to the broker as well. In other words, clients lost more than 100% of their money. The risk is unlimited.

https://www.elitetrader.com/et/thre...er-do-to-blow-up-his-fund-and-clients.327102/

I never know such a thing can happen as an investor in professional funds. I always assume risk is limited to 100% loss which is bad enough as a worst-case. I didn't know risk can be unlimited.

This is certainly a risk that all clients must be aware of. What are the kind of funds or fund structure to be aware when investing in professional funds to avoid this kind of unlimited risk? Do clients of CTA face such a risk?

When Amaranth and LTCM blew up, did their clients lose more than 100% of their losses?

From their (a.k.a. Optionsellers) December 15, 2010 Disclosures. First page; third paragraph (emphasis added):
www.scribd.com/document/141965374/Liberty-Trading-Disclosure-Document-2010

"...IF YOU PURCHASE OR SELL A COMMODITY FUTURES CONTRACT OR SELL A COMMODITY OPTION OR ENGAGE IN OFF-EXCHANGE FOREIGN CURRENCY TRADING YOU MAY SUSTAIN A TOTAL LOSS OF THE INITIAL MARGIN FUNDS OR SECURITY DEPOSIT AND ANY ADDITIONAL FUNDS THAT YOU DEPOSIT WITH YOUR BROKER TO ESTABLISH OR MAINTAIN YOUR POSITION. IF THE MARKET MOVES AGAINST YOUR POSITION, YOU MAY BE CALLED UPON BY YOUR BROKER TO DEPOSIT A SUBSTANTIAL AMOUNT OF ADDITIONAL MARGIN FUNDS, ON SHORT NOTICE, IN ORDER TO MAINTAIN YOUR POSITION. IF YOU DO NOT PROVIDE THE REQUESTED FUNDS WITHIN THE PRESCRIBED TIME, YOUR POSITION MAY BE LIQUIDATED AT A LOSS, AND YOU WILL BE LIABLE FOR ANY RESULTING DEFICIT IN YOUR ACCOUNT. ..."

 

[JSOP]

That is not being 100% truthful. The 100% honest truth is that clients can lose MORE than their entire investment. When investing in CTA, clients must be aware that the account is separate managed and they can lose more than 100% of their investment.

If they use margin. If they do not use margin, the clients would only lose up to 100% of their investment, whatever they put in. It's only when they borrow via margin to invest more than what they deposited that when there was a tremendous loss where the entire position value is lost, that's when the clients can lose more than what they put in because they now owe the broker for the money that the broker lent to them via margin.

If you want to make sure you don't lose more than you have deposited, just instruct your CTA to invest in a cash-only account or instruct the CTA and the broker to never use margin whatsoever.

 

[Robert Morse]

If they use margin. If they do not use margin, the clients would only lose up to 100% of their investment, whatever they put in. It's only when they borrow via margin to invest more than what they deposited that when there was a tremendous loss where the entire position value is lost, that's when the clients can lose more than what they put in because they now owe the broker for the money that the broker lent to them via margin.

If you want to make sure you don't lose more than you have deposited, just instruct your CTA to invest in a cash-only account or instruct the CTA and the broker to never use margin whatsoever.

Your comments are not accurate. There are no cash accounts or margin accounts with futures. Your put up a small value of the notion value of the forward contract for Risk. Futures accounts are highly levered but there is no borrowing.

 

[JSOP]

That's a separate issue. It's about proper risk disclosure to clients.

And according to NFA/CFTC, all CTA and FCM are required to disclose on all their publications that investing in derivatives carry extremely amount of risk and may not be suitable for all investors and you can lose more than your investment. And also past performance is not indicative of future performances. I am sure that those clients are presented these disclosures (if they are not then optionsellers.com and Cordier are in major violation of disclosure requirement by the NFA/CFTC here) but Cordier could've dismissed them as "standard disclaimers" like those ones that we see on our movie theatre ticket stubs (Enter at your own risk) and plus Cordier reassured them that they are "very safe investment" and he's very experienced he knows what he's doing and blah blah blah.

 

[JSOP]

Your comments are not accurate. There are no cash accounts or margin accounts with futures. Your put up a small value of the notion value of the forward contract for Risk. Futures accounts are highly levered but there is no borrowing.

Well he was investing in options, not in futures. That's different. I think options on futures are structured like options on stocks, no?

 

[JSOP]

From their (a.k.a. Optionsellers) December 15, 2010 Disclosures. First page; third paragraph (emphasis added):
www.scribd.com/document/141965374/Liberty-Trading-Disclosure-Document-2010

"...IF YOU PURCHASE OR SELL A COMMODITY FUTURES CONTRACT OR SELL A COMMODITY OPTION OR ENGAGE IN OFF-EXCHANGE FOREIGN CURRENCY TRADING YOU MAY SUSTAIN A TOTAL LOSS OF THE INITIAL MARGIN FUNDS OR SECURITY DEPOSIT AND ANY ADDITIONAL FUNDS THAT YOU DEPOSIT WITH YOUR BROKER TO ESTABLISH OR MAINTAIN YOUR POSITION. IF THE MARKET MOVES AGAINST YOUR POSITION, YOU MAY BE CALLED UPON BY YOUR BROKER TO DEPOSIT A SUBSTANTIAL AMOUNT OF ADDITIONAL MARGIN FUNDS, ON SHORT NOTICE, IN ORDER TO MAINTAIN YOUR POSITION. IF YOU DO NOT PROVIDE THE REQUESTED FUNDS WITHIN THE PRESCRIBED TIME, YOUR POSITION MAY BE LIQUIDATED AT A LOSS, AND YOU WILL BE LIABLE FOR ANY RESULTING DEFICIT IN YOUR ACCOUNT. ..."

Well according to this article by Bloomberg, https://www.bloomberg.com/news/arti...-hedge-fund-promoted-selling-of-naked-options, it was FC Stone who borrowed on margin against the clients' funds to cover so the clients were not specifically "called upon by your broker" to deposit a substantial amount of additional margin funds to maintain the position. Looks like once FC Stone just put in funds themselves into the account and then now put it on the tab for the clients to repay. From this disclosure, the clients were supposed to be called lot earlier to put in additional funds to maintain the position and if the clients at that point decided not to maintain the position, then they would've been auto-liquidated and they might have avoided the debit balance.

Just my take. I stand to be corrected.