Why the Rally Could Have Been a Bet Gone Wrong

Cramer senses that somebody's battle plan gone awry may have been behind many of the moves. He recounts his own firsthand experience with such an ambush.
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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."

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

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.

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.

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.

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

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.

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."

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.

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.

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.

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.

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.

Coke

(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.

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.

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.

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.

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.

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.

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

jjcletters@thestreet.com.