Cramer's Rewrite of His 'Why the Rally Could Have Been a Bet Gone Wrong' Piece

The trader details a bad trade he made in the past to illustrate how quickly things can go so wrong.
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Dozens of people asked me to rewrite this column, in part, I think, because of the need to hear that someone else has lost money besides them. Talking about losses is gut-wrenching. I don't mind doing it, though, because I have had more winners than losers and I am all about trying to make money for my partners and my readers. In this instance I made no money for anyone. But maybe I can save you money now by explaining why markets do counterintuitive things.

Why would the market rally so strongly after the "bad news" of a bias-tightening? So many of you asked me that question in your emails last night that I feel compelled to answer in depth because I don't think you would believe me if I just offhandedly said "because somebody is betting the wrong way."

(The premise of this piece is that for years people have made giant bets against the market. For the most part those bets have been wrong. We all long to hit the ball out of the park on the short side. In the hedge fund business, making money betting against stocks is a mainstay. But if you take a look at how the market has exploded in the last 18 years, you realize that the big bets against the market, for the most part, have been wrong. This piece details a very wrong bet I made.)

A couple of years ago, when I had an extremely hot hand, I made a giant bet against the market.

(There is nothing more dangerous than believing what you do will be right, simply because you are doing it. When you have a hot hand, that is what happens. You feel that when you make the bet, it will pay out. That's when you have to be most careful.)

I bought a large number of puts on the

Nasdaq 100

, a massive SPX in-the-money put position, and I compounded the activity by shorting at-the-money calls on a couple of weirdo indices that don't trade with great frequency.

(Here's a mouthful. Let's take them one at a time. NDX 100 is a highly illiquid index that hardly ever trades in what is known as "size." The market is really a 10-up market, meaning that you can only buy 10 contracts at a time. I bought 1,000 puts, though, in a combination of various strikes and I paid dearly for them because I didn't want a lot of premium. In other words, I bought deep-in-the-money puts for $20, $30 and $40 a pop. To make that bet, I needed "help," which is the generic term for meaning that I had to have a brokerage desk "position" me, or commit capital to facilitate the trade. You can't just go and make a big bet. You need a broker to take the other side of the trade. To do that he typically has to hedge himself or get short something like what he is buying for you. So, to talk you through it, if I wanted to buy large amounts of NDX puts, the brokerage house would have to sell them to me. That's because the market makers won't do anything larger than 10-lots because they are afraid of losing money. The broker who sells them to me is now short the puts, which means that if the NDX breaks down, he is short an instrument that will go up, and up big. That is an untenable position for a broker. So he quickly tries to short the underlying stocks of the index so he is hedged. That way he will lose on the puts but make it up on the short common. That's what positioning a trade is all about. As I also thought the market was going to go straight down, I sold calls on indices, betting that the premium would erode and the call would decrease in value. Again, the broker had to help me, this time by buying the calls I sold. Now, again, he is on the hook if the market tanks. So he again must sell stocks to hedge himself. He did not need to hedge himself on the SPX puts because that market is very liquid. But on the other two trades he committed scads of capital and did his best to hedge.)

I will spare you the details of what made me make this bet other than my own hubris and a belief that, like yesterday, some piece of news would be interpreted negatively by the market and I would profit from it. At the time, the market had been oversold, meaning it had been ugly as it had been for the few weeks leading up to yesterday.

(We were in the exact same situation this week. Someone had made a bet earlier in the week ahead of the Fed that required a lot of capital to be committed. He thought he could clean up on the short side. Instead, he got his clock cleaned, because the market was oversold going into the week and didn't want to go down any more. The bet was made in SPX puts. You can tell that because it was the big index names that rallied, not the NDX or the little stocks. In fact, in Friday's plus-112 session the advance/decline was negative. Someone probably thought the S&P was going to go negative for the year. Instead, that person probably went negative for the year from this bet.)

My partner,

Jeff Berkowitz

, was in Italy at the time. I remember because when he would call me, it always sounded like when the audio goes off on a Monday Night Football game and then has that backup system that sounds tinny.

(Oh, could these calls be painful. When someone calls every hour and you are losing hundreds of thousands of dollars every five minutes, the meter is really running.)

Of course, that was because he was calling from his tile bathroom in Venice as he did not want his wife to know how neurotic he was about our positioning. Sure enough, the next day after I made my bet, I got my generic piece of negative news. I knew it would be received negatively because the nattering press nabobs had said that it would be received negatively.

(This was also the case this week. To listen to the media was to believe that the market would be destroyed if the Fed tightened bias. That turned out to be nonsense. In fact, if John Berry hadn't gotten this one wrong, I think the market would not even have paused, but there was some surprise factor that led to selling briefly, just briefly.)

But nobody sold. In fact, nobody did much of anything. In fact, a tree fell in the stock-market woods.

(This is the worst thing in the world when you are short. When the sellers don't materialize, it drives you batty. You begin to wonder what is wrong with the world. Maybe you should have been wondering what was right with it.)

When the event occurs and nothing happens, let me tell you what really happens. The people who executed the trades for you either a.) respect you and mimic you, or b.) tell others about your big bet, or c.) smell blood when nothing happens.

(Now when firms positions funds, and they respect the client who is doing the betting, they tend to bet with you. They take a little extra or they hedge a little more. They might want to get even more short than you, betting that you know something. As I had had a hot hand before this, I had many, many people piggybacking off me. When nobody sold, I knew that all of the other people who mimicked me would cover. And I knew that the sharks would hear very quickly about my bad position, watching me like a swimmer who is bleeding.)

They then panic if they are betting with you. Or they let the word out that your fund is leaning the wrong way. Or they betray you in some honest way like "Cramer's betting the wrong way on this, and it will be very hard for him to unwind these positions."

(You know they do this. If you don't, you are just stupid. People speculate all of the time about what big money is doing. Heck, Ron Insana reports on this stuff constantly. Word gets around. It shouldn't, but it does.)

Now it is entirely possible, you might be saying that all of this is my paranoia. If you have that thought, you have never worked on a big-time trading desk, where bets like these are the grist of the day's gossip.

(People talk. They don't want to wipe you out. But they can by their talking.)

No matter, the event produced no sales. So as a discipline, I had to take my trades off. Or let the puts rapidly go to zero. Because I shorted illiquid calls, I had no choice. If the market started ramping against me, I could owe millions of dollars.

(When you short anything and it goes against you, the pain is great. When you short something that is illiquid and you need someone's help to cover -- just like you needed someone's help to buy -- that someone owns you. He can crush you. He can stomp on you. And he can pretend that he is on your side the whole time. You are at his mercy.)

Keep in mind, I am no neophyte. I know the rules. I know when a trade goes awry, you must move swiftly to contain the losses. I am bloodless about this stuff.

That day, however, the moment I went to cover the calls first -- because that is where most of the liability stared at me -- I felt the way a general must feel when he discovers that the enemy had found his plans in some courier's knapsack shot down over enemy lines.

(There were no offerings and the firm that put me in the trades didn't want to help me get out at reasonable levels. They wanted their pound of flesh. They wanted their bond.)

Every move I made to unwind was anticipated. Every attempt to bring in my shorts was met with others trying to do the same. It was Pickett's charge, and you could tell that the battle and the war could be lost right there, that Friday, while Jeff was hiding out in his Venice bathroom.

(I kept begging for offerings, begging for the positions to be unwound. Finally I just took everything up even after it had already been taken up ahead of me and I paid absurd prices that would not be seen again for some time.)

Funny, for two hours we had an open line as I tried to give him the shifting picture of the battlefield. Things were happening fast.


(KO) - Get Report

was jumping up a couple on nothing. So were the drugs. The offerings in tech were disappearing faster than I had ever seen. As we went through resistance level after resistance level, more short-coverers joined in the rout. The next thing I knew, the puts, which I had largely ignored while I frantically sought to cover the calls, had gone to next to nothing. And these were puts with 15s and 16s in front of them, not quarter- or half-jobbies.

(This is what you saw all week -- the drugs, the sodas moving up. That was someone trying to unwind a really nasty short on the SPX coupled with mutual fund and index fund buying.)

The buying ran right through to the bell. One of those plus-2% days that have the TV folks ecstatic but wondering about follow-through. I had one of my worst sessions ever; I was completely annihilated by an up tape. That crimson flush came from the double whammy, the "not only did I not make but I lost a lot of money" reality that no investor who doesn't trade understands. I was ashamed.

(Of course, this is what makes the short side such a nightmare. You have to explain that while the market was up 20% you were down! People want their money back pronto when that happens.)

The commentators, of course, were spooked by why the market took off so fast. Some of them even called me to ask. I had to laugh amid my near-tears as I hid behind silence. "Yeah, it was me. I leaned the wrong way, and I got creamed." Nah, I ain't that stupid. Like every hedge fund manager except me these days, I said I knew nothing. But Jeff knew. He came home. He had to. We had some damage control to do -- and fast.

(That's why I never believe anybody when they say how they are doing in this game unless the numbers are audited and published. It is no one's interest to say they are down. No one. Because of the openness with which I lead my life, I had no choice and could not hide during my crummy year last year, even though much of the disappointing performance could be tied to redemptions. Nobody cares; there are no asterisks next to performance. This is why I feel badly for Julian Robertson. If no one knew how poorly he was doing, believe me, he would be doing much better. People shoot against people who are down all of the time. It is a jungle out there.)

What happened next was entirely predictable. Without me in the market furiously buying indices that represent millions of millions of dollars of stock, and without all of those clowns who shot against me in the market buying, the market collapsed rapidly under its own weight and the whole move -- Cramer's move -- was undone in a flash. Once you have taken out the panicked shorts, there is not much buying left.

(This is always the cruel irony. When I was begging for those offerings, the market was moving unnaturally ahead of me and then moved even more naturally when I bought the market. Once I was cleaned out, there was no one left to buy!)

That's why, while I felt the action yesterday was terrific, I also know that somebody's battle plan gone awry may have been behind many of the moves. Maybe some hedge fund's plan got captured by the enemy, and what we saw was an ambush of 200-point proportions.

(I think this occurred. In fact, I think someone was caught short and chose not to cover because of the employment number and then, when no one sold, took the second leg of a very big bath.)

Let's see what this market trades like today with the covering out of the way. And remember, a lot of what you see in the market is simply the ramifications of some guy like me making an outsized bet on something that is supposed to occur but doesn't. The only difference is that I am honest enough to talk about it in hindsight. I am sure the guy who got caught yesterday won't have to do a mea culpa to anybody but his partners.

(You will never know who was short and when he covered, but there was a lot of short-covering going on. That said, with the Fed now probably sidelined for a month, we have plenty of time to buy ourselves! There is plenty of money coming into the market and it looks like all is clear for this expiration.)

James J. Cramer is manager of a hedge fund and co-founder of At time of publication, his fund had no positions in any stocks mentioned. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may 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 at