(Editor's note: In what is a weekly exercise, James J. Cramer, our daily columnist, revisits a previous article to provide a deeper explanation to his sometimes complex commentary. This is an invaluable deeper look into what goes through a trader's mind. For the original story, click here. Let us know how you like it by sending a note to email@example.com.)
were alive, the pendulum pit-man, yeah, he'd get it. Couldn't be
, too upbeat at the end. No, much better, I want
, yes, get me that grizzled story-teller from Jaws. He could visualize the tale I am about to tell. He survived the shark-infested waters that swallowed the
. How about Quint, trapped in Youth, by
(This is just me showing off in a reprehensible sort of way. I am invoking a bunch of my favorites, including that Robert Shaw figure from Jaws, Philadelphia's own Edgar Alan Poe (%^$% you Baltimore) and our own late 20th century Dickens, Steve King, but lest you figure me for a commercial/pop enthusiast, I bring up Conrad because everybody knows, from Lord Jim, what a bore he was, and only the real English-as-first-language geeks liked him. Could have done a Joyce/Faulkner number here but this isn't salon.com, or the ever-hyped Slate.com, either)
Perfect. Pass the bottle, and let's get started.
The setting, my old office, four floors above the stinking inferno of the old Delmonico's on Beaver, south of Wall. We had to nail the windows shut in that place, to keep the steak fumes out, and the desperate in. Glad we did, because on this particular third Friday in April open windows would have stamped "finis" to a storied career before its time.
(Options expire every third Friday of the month. The month in question, April 1993).
We had just about put paid to another difficult, crazed 98-octane option expiration. Some 36 pages of position sheets were due to come off, most of them successful, bizarre permutations/mutations, with tons of gamma.
(In our business everything, literally everything, begins and ends with position sheets. These are the sheets that list the positions you own. It is inviolate that these must be right, and I have fired a half-dozen people because they weren't and I traded something I thought I owned, that I didn't. Gamma refers to a concept involving getting longer as a stock goes higher. Thirty-six pages is an obscene amount. Someone with my amount of capital should have had five double-spaced pages of positions at the most. But I was into some compound-complex Latinate combos at the time that swelled them to mammoth-sized proportions.)
My largest position: a distended three-pager of
calls designed for the stock to go out at 110 for maximum voltage. It worked, because with just minutes to go before expiration, Intel was at $114. There were long April 90 calls, long April 95 calls, long April 100 calls, short April 105 calls and a massive short April 110 call position. And then a long April 115 call position to play even more upside if the stock kept ramping as it had in the last few weeks because of a powerhouse 486 ramp.
(What a mouthful. I probably lost one-third of you with this paragraph alone. Let's back up. If I liked Intel I could own Intel common stock. I would pay a ton of money to get a big position in, as the stock was about $90 when this story started. Or I could buy calls that approximated the value of the common but had some premium to them. When I started this exercise, I first bought Intel April 90 calls. They were out of the money, at the time, which meant that Intel was lower than $90. Over the course of the next month, Intel kept going higher and higher. I kept buying calls at a higher strike, first the 95s and then the 100s. Why did I not consolidate? Because I would have had to pay extra commissions to unwind the positions and because the spread -- the different between the bid and the ask -- would have blown away some of my profitability. So, I had three instruments that all mirrored Intel on the way up.)
In other words, I had effected a spread to take the position off. Long the deeps and then short a succession of higher calls that were meant to be exercised by others to take the position off but leave me slightly long.
(Newbies, visualize a stock that I am participating in one-for-one through calls that I am selling calls against to spread and pick up premium, and hopefully get called away in the end. That little meager explanation sufficed for no one, so let's go more in depth. Intel jumped about 20 points during this period. I had no idea when Intel was going to stop going up, but be darned if I was going to cut off my upside at $105. So what I did was sell April 105 calls for about $4 -- creating a sale at $109, synthetically. That meant that if Intel closed above 105 on the third Friday in April I would lose my stock at the equivalent of 109 to those who had bought those calls. But if it went out below 105, I would keep all my stock. Subsequently, the stock blew through 105, and I started selling 110 calls for the same reason, to take off my position and capture options premium. Those not with me, don't worry, I will repeatedly revisit this concept.)
I wore this position around my neck like a tire filled with gasoline. As long as no one smoked near me I could toss the tire at 4:10 p.m. -- old options expiration time -- and be home free. But if Intel were to experience a short, sudden jolt, I'd be necklaced sure as if I were a traitor in the townships.
(In retrospect, this pre-Mandela bit of South African lore didn't work. Nobody complained but nobody praised it either. What I was trying to do was set up a picture in your mind of a dangerous situation that would cease to be dangerous provided Intel didn't reverse itself suddenly and plummet below 110. As it was at 114, that was highly unlikely. If I had it to do over again, I would probably use a more topical analogy, like maybe the one-in-a-whatever possibility that the Titanic would sink if it struck an iceberg.)
caught Intel for sale. At 3:51 so did
. At 3:52
had size to go. At 3:53
hit us with 50 to go, pronto. Who said this was a no smoking area?
(For anyone who has never worked at a large brokerage house or a buy-side fund, this probably seemed very foreign. All day long at my firm I sit and listen to brokerages coming to me with merchandise. They might have Cisco to buy and Intel to go. Or Compaq to buy and Dell to go. Usually it is random; there is no pattern to the selling. That's why it is so scary when a bunch of firms all hit your wires, or direct telephone lines, with the SAME merchandise. That means, whoops, somebody knows something. So look out below.)
I don't even remember the stock trading with a 113 handle. Or 112 for that matter.
(More lingo. Handle means what is the big number of a stock, before the fraction.)
We hit wire after wire; nobody knew a thing. I remember feeling flushed. Knowing that as long as the depth gauge stayed above 111 I was fine, as the people who were short my 110 calls would come to my rescue. Below there I was a deadman.
came in and out of my head.
(Thresher refers to a U.S. submarine that disappeared in the Atlantic in the 1960s. Really scary. People who were short the 110 calls is a mistake in my text, but by now I've probably lost my faithful editor Dave Kansas. It was the people who were long the 110 calls that would come to my rescue. I am short them. The idea was that if the stock closes above 110, the call-holders would exercise the calls, forcing me to fork over the common stock. That's fine. I had plenty of stock available courtesy the April 90, 95 and 100 calls. All of this is to say that I expected Intel to be called away because the April 110 calls looked to be in the money with 12 minutes left to go.)
At 3:56 I asked Sal Schillace, my options assistant, to take some evasive action, let some more April 110 calls go. "They have no premium," I remember him telling me. "I don't care. The Gods know something we don't." I assured him. "Sell the &^%$&%$%^ things. $&^%$%^$#." Done my way. 500 times.
(We sold 500 April 110 calls, expiring in about 14 minutes, for about a dollar, through the common as the stock was 111.25 bid. Here is an extremely important concept. When you want to short a stock and can't get an uptick, you can go into the call market and bang out the calls. No upticks are needed. But the market makers aren't idiots. They don't stand there and let you beat them up. In this case, I would be shorting a call at parity with the common stock. But after you add commissions in, my net cost would be below the cost of hitting the common stock bid. In other words, this situation made no economic sense other than to someone who was desperate and believed that Intel was going to drop a point in the next four minutes. Which I was. So this worked, as we shall see.)
"We're gonna come in short Intel now," I remember Sal telling me. I responded: "No we're not. Something's wrong. Something's very wrong. They are going to have to stop trading Intel."
(That's me playing Karnak; I was so confident that somebody knew something negative about Intel that I didn't that I took action on my instincts.)
Instantly the stock flickered at $110 bid, reflecting my pressure as well as the pressure of the rest of the clued-in western world.
(The people who bought my April 110 calls probably turned around and whacked common, so they would be long the call and short the common stock. That way they have very little risk to the position. That is a flattening trade and is done all of the time by market-makers to lay off risk. Of course, it puts pressure on the common stock, but it is really just transferring the pressure from the options to the common.)
"Intel HALTED," I remember my trader shouting moments after my negative prognosis. "News!"
Intel flickered at 110 and went out. Frozen. At 110.
Oh my God. At 110 if nobody exercised the April 110 calls I would be long 300,000 Intel on Monday morning, and now there was news. News is bad news when a stock drops like a rock before it is halted.
(When stocks go out at their strikes, some people exercise them and come in long the common stock, while others just accept a worthless verdict and move on. When you are short calls, you never want them to go out at the strike, because you have no idea what your position is until all of the call holders are sorted out, sometime over the weekend. Remember what I said about the importance of knowing your sheets? Well, now imagine that I had put on a position where I had NO IDEA how much Intel would be called away on Monday because I had no idea what the April 110 call holders would do. For more on this, check out my rollover piece from Friday.)
Ineluctable. Given. Earth is round. Given.
Moments later, news came over:
Judge rules in
favor in 486 suit. Intel to lose monopoly. AMD by a decision, a fouled decision by some punchdrunk on-the-take Nevada judge. Ah, if it were only just a prize fight.
Federal court. Good as law. End of monopoly as Intel knows it.
(Intel has had many iterations of microprocessors. Before Pentium came the 486. At the time there was no alternative to the 486. AMD was suing for the right to copy this chip, a right that the company thought Intel had granted them. This court victory gave AMD the right to the 486 plans, thus ending the monopoly and causing profit margins for Intel to shrink, as they would when any monopoly becomes a duopoly.)
When you get a piece of news that is bad in our business, you almost instinctively try to visualize in your mind when the sting will go away. Was this a three-day piece of bad news? A five-day piece? Was this a quarter burner? No, I told everyone in the room, we just lost our year. "Game set match." We are long 300,000 Intel if nobody exercises those April 110. We can't absorb that kind of loss. Thirty points of toxic, steaming loss coming at your wide-open eyes.
(Here's that position squaring again. Exercising all the April calls I was long, minus the April 105 calls -- those were deep in the money, so no question there -- would put me long 300,000 shares of Intel if no one exercised the April 110 calls that were worthless, by virtue of the stock going out at the strike.)
I hadn't cried since my Ma had died seven years five months and a handful of days before. But I wanted to cry. I wanted to cry if only to show emotion worthy of the millions of dollars that I had just lost in less than four minutes.
But I was too numb to cry. Paralyzed.
I told my partner Jeff to go through the motions and check the ruling out. I told Sal that he should do his best to try to find out over the weekend how many of the April 110 calls were exercised. Thank God I was short about 1,000 April 105 calls from earlier in the month when I thought Intel was going to top out at about 108. Otherwise I would be long 400,000 Intel, 400,000 shares of a stock that was sure to be down 25 points on this decision.
(Again, a bunch of presumptions. You can find out on Sunday how many of a given group of calls gets exercised. That's what I was instructing Sal to do. The April 105s, five points in the money, were a given that people would exercise, given that the stock closed at 110.)
Every time I tried to multiply those two numbers I couldn't believe how many zeroes I was about to lose. A light went off in the back of my head: gotta call the partners. Gotta let them know. Ten percent of my capital; vaporized. No trace.
(I know I seem like a Lone Gunman, but I actually work for people besides myself, people who have entrusted me with their capital. I like to keep them abreast at how I am doing every quarter, but this problem seemed so bad that I debated calling them and telling them how I had failed them.)
The horror, the horror, up the river, without Martin Sheen to take me out of my misery. Terminated with just enough prejudice to make it home to my wife, who will never ever understand what happened.
(Reprehensible old me again, proving I know both Heart of Darkness and Apocalypse Now. My wife never understood the obsession I had with calls, so this one would really leave her cold.)
I put my coat on and found my token and strolled down the hall on the way out. I didn't even want to wait for my sheets. I just wanted to go home. Maybe pour a scotch. Better make it
Johnnie Walker Red
, or worse, stock.
. Who could afford single malt after a breakdown like this?
(Todhunter is knock-off liquor that tastes like a knock-off. It is also a stock that lost me ten bucks. Single malt is rarefied Scotch. JW Red is a cheap blend that has a lot of sugar in it, a product of when the liquor companies tried to make scotch more popular, particularly to women, in the 1950s.)
And then it hit me. There was a way out. I shouted to my trader to find out where anybody was making the stock, but nobody was trading.
(When stocks get halted sometimes third-marketeers make markets in stocks anyway, but this time nobody was trading it. It was anybody's guess what Intel would be down on this.)
I went into Jeff's office, which even though he was still going to business school at night was already nicer than mine, although directly above the grill vent, making Jeff always seem like he just ate a greasy burger and had wiped his mouth with his Armani shirt.
(Jeff objected to this, citing his preference, even then, for Zegna shirts.)
I closed the door. "Jeff, you know this stock is going to $85 on Monday on this." Down 25, easy, he agreed.
(How we were certain about this threw off a lot of readers. Most people when the news came out had no idea how much it was worth. Some thought a half-dozen points. Others thought that it had already lost four points from 114. But I am an Intelaholic and I knew this was a near-death knell blow for the boys from Santa Clara. A couple of billion in market cap had to come off to reflect the end of Monopoly. That was gutsy, as you will see.)
"How would you like to be short this stock at 105?"
"How could you do that?" he said, dumbfounded.
"Watch me," I said.
"Sal, get in here." He scrambled in.
"Sal I don't want you to exercise any of the Intel deep calls." He looked stunned.
"Jim, some of those are 20 points in the money. That's millions of dollars that you are throwing away," he said,
"Nah," I told him. "Those calls are worthless. And I know it. Our only hope is to pass on those calls, and bet that people exercise the 105 calls that we are short and a fraction of the 110s, and we will be short a &%$^%$^%load of Intel with maybe a 109 basis on Monday."
(Okay, this is the crux of this article. If you know that a stock is at 110, where Intel closed, you would of course exercise any calls that were in the money. They have lots of worth. But now examine what a call really is. Take the April 90 call. That's the right to buy Intel above $90 on the third Friday of April. That's worth $20 if the stock is at $110. But how about if the stock is worth $85? That right is worthless. Why would you pay $90 for a stock that sells for $85. But you had to have the conviction that Intel would trade below $90. If you thought the stock was going to be at even $93, you wanted those calls, as they had $3 in worth. But I figured they would be worthless. The reason why this was so brassy is because I figured that the guy who was long the 105 calls would exercise them even though I was passing on the 90s, 95s and 100s!!! And I was right. The April 105 call holders ALL exercised. They must not have believed that the stock would open down as much as I did.)
Sal smiled. He got it immediately. He knew I had a plan. Nobody likes it when their skipper looks like he's about to cry, let alone leave. Everybody likes it when the skipper is smiling, particularly when he's got a plan that will turn disaster into victory.
(Skipper. Reading a fabulous Korean war book, by Owen called Cold as Hell, about the Chosin Reservoir retreat to victory by the Marines in 1950, and the author is endlessly using the word skipper, so it crept into my writing.)
"Done your way. I'll tell Goldman."
(Quick shorthand. Done your way is like "aye-aye" in our business. Telling Goldman is necessary because Goldman is my broker where I keep my securities. Goldman must be instructed by hand about what to do with all calls that are questionable. As Intel's stock closed at $110, all calls below there would be automatically exercised, even though Intel was due for a huge fall on Monday.)
"Not enough." I said. "I want you to send it in writing, under my signature, that I am not exercising calls that I know seem to be twenty points in the money. I want them to acknowledge it. I want them to agree to it."
He made a bunch of calls, sent a bunch of faxes, and then assured me that I would let these calls, worth some $3 million on paper in the margin run for Monday, go out worthless. Like so many out-of-the-money rip-ups.
(My concern here: that the Goldman guys would think it was a mistake that I passed up exercising calls that on my margin run were "worth" many millions of dollars. Had we not taken these precautions I am highly confident we would have been screwed.)
I grabbed the subway, got home, and poured myself a
, not particularly a propos of a three million dollar write-off.
(One of the better, but not the most expensive, single malts, very peety and smoky. The Trading Goddess says she'd rather drink peat moss-flavored Benadryl.)
But, if I played it right, and I calculated correctly, I should make just about all of it back on Monday if the papers played it as negatively as I thought.
If the analysts did the downgrade thing. If the world was as fearful as I knew it would be. I saw the headlines, line by line, word for word. The negative
story appeared in my head as surely as if I were the hapless Intel reporter assigned to write it. More than anything, I needed Intel, a position I had wanted to be up the most, an hour before, to be down the most possible on Monday. I needed Intel to be puked out surely as if it were raw egg down the throats of every portfolio manager in the land.
(I needed Intel down a huge amount or else my gambit would fail and I would be short the stock at a price that would have left me wishing I had exercised the calls. Let's say Intel were to be down only 6 points on Monday. I would have wished that I had exercised all my calls, and then I would be long a lot of a stock that was beaten up. But if it totally collapsed, as I was betting, I could hit a homerun. Keep reading.)
Our game is like that. Intel had been like a brother to me. Now it was my evil twin.
(Psychologically, anybody who has ever owned stocks has to picture themselves rooting against their stock. It would be as if me, a lifelong Sixers fan, wanted Havlicek to steal the ^^%% ball in that horrid Celtics game. Imagine betting against your favorite team on a dime!)
On Monday I came in and found myself short about 180,000 of Intel. All of the 105 calls had been exercised, and a giant chunk of the April 110 calls had been exercised too! It was beyond my wildest dreams that any of the 110s that I was short, and I was short about 4000 of them, would have been exercised. But a fifth of them were, by individuals clueless to the impact of this court decision against Intel.
(Over the weekend there is a lottery held. If you are short 1000 April 110 calls, and there are 100,000 April 110 calls in existence, an unknown percentage of call holders are going to exercise them. By Sunday I learned that a fairly high percentage of people, given the circumstance, chose to exercise the April 110 calls. Out of 4000 calls, 800 of them were exercised.)
All morning, beginning at 6:15 a.m., I started reeling my short Intel in. Fishing with magic bait. By 9:30 I had brought in half at about $83.
(By Monday everybody knew that this court decision was a stunning negative for the giant chipmaker. Beginning early Monday morning institutions started selling Intel recklessly, betting that the company had bought the farm now that AMD had the right to copy the 486. These sellers were wrong because the chip turned out to be harder for AMD to make in volume and because Intel was able to speed to the Pentium, which could not be copied by AMD.)
I paid $86 on average for the rest, and by midday I was long 100,000 Intel with an average of about $85.
(I bought the stock because I believed that Intel would come back. That was just my faith, which the company requited.)
I had made 25 points on the 180,000 short. I had lost about $3 million on the in-the-money calls I had chosen not to exercise.
I came out ahead.
And I went on to have a fabulous year.
Because you can come back from anything. If you just keep your head.
(This is me just reminding those of you who get down that had I simply left the office that day downcast with my spirits broken, I would have had a down quarter. Instead, with some clear-headed thinking, I had a great quarter. This is the only instance I have ever had where I cashiered $3 million and made it back in a weekend, but I am keeping my eyes out for more!)
Pass the bottle.
(That's the phrase that punctuates Conrad's novella, Youth, which, besides Secret Agent, is his best. We would all be reading Conrad to this day if we had been assigned Youth in tenth grade rather than that wretched Lord Jim.)
James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com. At time of publication of this version of this story his fund is long Intel. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Mr. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he welcomes your feedback, emailed to