Cramer's Rewrite of His 'Options Lovers, Listen Up' Column

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I picked this brief piece because I wanted to spend more time on a longer piece on what happened this week and because I thought, tactically, this piece helped explain some of what occurred on the final two days of this expiration.

Options lovers, listen up. Yesterday I did one of the dumbest trades I have ever done. I was sitting on a raft of

Golden State Bank

(GSB) - Get Report

October 15 calls -- 3,000 of them.

(I bought these calls because I thought there was a chance that the Fed would ease 50 basis points. This company probably has about the most leverage to short rates that I could find, meaning that it had the most to gain from a rate cut in terms of real operating profits. I thought it would be a good spec. I paid $3 and change for these. But for the purpose of this piece, most cost is irrelevant. It's what they were worth in the end that mattered.)

They were looking worthless. Real worthless. I figured they were goners.

(We call them rip-ups. These are options purchased that go out worthless. On my sheets they were valued at about three-teenies apiece, so that when I looked at them everyday, I kept imagining that there was this asset, worth about $60,000 on a sale, that would be worth nothing by Monday. I kept thinking that this $60,000 would be worthless and that anybody who would let $60,000 go down the drain is an idiot.)

So when someone bid me 25 cents for them, I sold a thousand of them.

(The someone who bid me for them was the same outfit that sold them to me. That's natural. He wanted to close his books on them, I wanted to close mine. He didn't want to be short an asset where he could only gain $60,000 but had unlimited downside. Remember, the call can go to zero, but it can skyrocket, too, as we shall find out.)

Wow, $25,500. Smart move?

Wrong! Today those went to $2.

(They went to $2 because the Fed eased. They went to $2 because the Fed surprised everybody -- and believe me, everybody was surprised. Had I held on to that thousand lot I would have had $200,000 instead of the $25,000 I collected. That's eight times what I sold them for. Amazing.)

Lesson No. 1: Never, ever sell a call for a quarter. Because you never know when the unexpected will occur.

(In other words, let's say I put this trade on and I didn't get what I wanted from the Fed. I should have immediately sold common stock against the call. Or blown out the call when it still had money. As the stock subsequently dropped to $10 soon after, I would have had a fabulous trade, shorting common at, say, $18, and then bringing it in at $10, and then having the call been bought and paid for and therefore forgotten about. So when it came back to life I would have been in clover. Or, if I had just banged out the call when I could have, I would have taken a loss, but not a major loss. Having failed to do either, what I should have done is mentally taken that call and used it as upside insurance. Put it another way. Let's say you thought there was a chance for a great rally based on a Fed ease. Why not pay a quarter to own the rights to Golden State above $15? But I neglected to think of this call as upside insurance. Instead I just wanted to capture some worth. That was a big mistake, as accident I was insuring against, the rate cut, came during the expiration period. I would not have missed the $25,000 in the vast scheme of running a multimillion-dollar portfolio.)

I used to teach this at Goldman. But I was so beleaguered, so unwilling to see a position go to zero, that I blew a third of them out.

(When you are beleaguered, you make emotional decisions. The pure and simple insurance decision should have been made not in the heat of battle and been adhered to. The loss had been booked mentally. No reason to take it. Just leave the darn thing on.)

Silver lining: I kept two-thirds of them.

(The story ends well. I sold 200,000 shares of common stock at $17.5 Friday, capturing a very big gain over where these calls were on Wednesday, or booking a small loss versus what I had paid for them. But, can you imagine how many other people out there had calls like this that they held on to, that came back to life, and haunted those who shorted them? I think these coverers played a part, not the part, but a part, in the turn the market had at the end of the week. There were so many people short calls for a quarter that failed to bring them in that they took huge pain and brought them in up high on Friday. I know I had one. I was short hundreds of Schlumberger October 50 calls against a long position I had in Slob. I never figured they would come back. There I was frantically paying a half dollar for something that I could have bought for an 1/8th of a dollar the day before. Glad I paid a half. They went out at $2.)

And someone is still short. Wrong and short.

(The people who sold me the GSB calls probably had to buy GSB on Friday or buy the call back. They were in the analogous position to me with Schlumberger.)

Let's go over that lesson again for the uninitiated: Never blow out calls for small change. Never.

(I wanted to drive home this point. I had other calls this week, like Ford and GM out-of-the-monies, that I did purchase for chump change at the same time I was selling the GSB's that were triples by week's end. It was just that kind of week.)

****

Random musing:

Trading Goddess says foul: All bets were off if the Fed eases. Ah, the old hedge of the hedge.

(Just to go over this for one last time. When my wife came in to work with me, she said that if the Fed didn't ease it would be Katy Bar the Door. It got interpreted as "get out" in the headline, but she was much more subtle. Still, if you did not think the Fed was going to ease, and there wasn't much sign that it would, you would have sold when she said sell. And you would have missed a great rally. I chided her about this, but she kept saying that if the Fed eases, all will be well. Boom, Fed ease. And the market ramps. Caveats make the reputation. Of course, she now wants a pullback to get more in, but that rallies should be bought not sold going forward.)

James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com.

At the time of publication the fund was long Schlumberger, though positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. 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 invites you to comment on his column by sending a letter to TheStreet.com at

letters@thestreet.com.