Red Skies

As I have been traveling over the past few weeks there have been a number of days that I have not had the occasion or opportunity to watch the tickers. This has not been an issue for me currently, since I don’t have positions active that require my immediate attention quite like I did back in the spring of 2010.

Back then I had accumulated a rather large clutch of call options in that Wildcatter ATP Oil &Gas I mentioned previously. After my initial success with options I had started to fancy myself as an astute speculator and decided to up my position size by many orders of magnitude.

Soon after, some bad news had hit the wires about one of their deep-water wells and the stock had immediately slumped from $18 down to $12 in one month. This left me withstanding a rather shocking and large drawdown in their value. However in late February of that year the stock (along with the broad market) had come roaring back and I had been made whole again by early May.

There is an old nautical saying that goes like this: “Red skies at night a sailor’s delight, red skies at morning sailors take warning”. It is based on practical seafaring experience that guides seamen to be prepared for an incoming storm if the early morning sky is infused with a reddish hue.

I mention this because on the morning of May 5th my bags were packed and my wife and I were about to leave for the airport for a long awaited trip to Maui, Hawaii. Before we left for the airport I wanted to take one last look at the tickers. In recent days I had seen the value of my positions swell greatly in value as ATPG and the rest of the market had enjoyed a bull rally. It appeared in most every respect as if our travels were coming at a time of smooth sailing for the markets.

This particular morning however had started off with a bit of a different tone, with many names and issues showing a decidedly negative action in the morning session. I rubbed my eyes and looked over the quotes again a bit quizzically trying to decipher why they had been so active and positive in the days prior, but were now acting in a manner that suggested urgent liquidation was the order of the day.

Stock after stock I quoted indicated that something was amiss that morning, yet I was leaving in mere minutes for the airport. There was not really time to do anything, unless I was prepared to take immediate and decisive action.

A portion of the call options I held for ATP Oil & Gas were June expiration and a portion were even further out in time, and as of that morning all were now solidly in the money, I felt no sense of immediacy. Furthermore the stock had just broken out above important prior resistance at $20 per share only days before. All indications were that this new higher plateau was certain to be maintained, short of any company specific news that could change its fortunes.

Off on our trip we went and my wife and I landed safely on our version of paradise some five hours later. After emerging from the baggage claim to the scent of tropical flowers and the views of palm trees gently bending with the constant trade winds, any thoughts of the stock market were far from my mind. That is until my phone rang while I was waiting outside the car rental terminal.

It was my cousin/broker calling, he told me that the tone of the session had deteriorated as the day went on and had ended even rougher. ATP Oil & Gas had slid under the $20 level it had broken above just days before, into the closing prints.

He wanted to know if he should sell out of my June calls the next day at a modest profit. This would ensure that if any further softness were to overtake the market in the coming sessions we could at least guarantee that we locked in some immediate gains, as the Junes were due to expire in six or seven weeks.

We decided that Cuz would watch the market and especially my wildcatter closely the next day. He would call me if things continued to deteriorate and I would make a decision at that time. If the day’s action was an isolated incident then I would continue to hold my position with the prospect of selling a good portion at yet higher prices in a week or so, when I returned from my trip. I hung up the phone and resumed my tropical adventure immediately.

The next day was glorious and I was certainly not thinking at all about stocks or anything much beyond the incredible view from our lanai and whether to book a morning or evening golf round when my phone rang and yet again it was my broker.

“MP, have you been watching what is happening on CNBC?” Cuz inquired.

“No, are the markets down again today? How is ATP doing?” I asked.

Breathlessly he went on to describe how the markets had been up on the open and our positions had started to recover from the previous day’s weakness so he had not felt any need to bother me.

He went on to say that then something unusual had happened on the exchanges. The Dow had dropped over one thousand points in mere minutes. Talking heads were blaming it on a glitch or some fat fingered trade. I flipped on CNBC and watched in shock as I saw the huge gash in the intraday chart and my head started spinning.

As my cousin and I were talking, the markets were coming back from the lows and it seemed that it all might be much ado about nothing. Although he mentioned that ATP had dropped to as low as $12 per share and was now trading at $16 and change. It went without saying that I was taking a large beating on my call options.

I decided that since this seemed a bit of an outlier event, maybe it was best to take a measured approach and not make a rash decision. I didn’t want to dump at a moment of extreme illiquidity and into panic selling. Option pricing was very spotty and the spread between bid and ask was as wide as the Grand Canyon. The reason, as you may have already surmised, was that the 2010 “flash crash” was going on at that very moment.

Over the next few days I checked in periodically with Cuz just to make sure that things were not getting materially worse, but as it happened to work out prices seemed to stabilize over the remainder of my week in Hawaii. Cuz assuaged my fears and I decided to deal with things decisively upon my return.

Back home the next week, I rolled up my sleeves and surveyed the carnage. The markets which had shown a bit of resilience in the days following the great crash seemed to now be sagging back towards lower levels that had been breached on that day of extremes.

There was no doubt that my positions had taken on a significant bit of water and now as I returned back to the helm of my financial frigate, I had choices to make. Scanning the news I noted that there was no company specific reason that my little meal ticket should have slumped so hard and not returned back to fair value as had many other issues. For some reason ATP Oil & Gas could not seem to get off the mat and was trading around the $16 level.

At this moment I made a fatal error in judgment.  I did not decide to close out my positions, not even the June contracts. I say this was a fatal error because around this time the BP oil spill happened and President Obama closed the Gulf of Mexico to drilling.

Since my wildcatter was heavily leveraged, it was relying on the production from its new Gulf of Mexico wells to meet some crucial debt covenants. This was a real crusher. Within days ATPG’s share price went over Niagara Falls and in my slack-jawed amazement I witnessed a sub $10 print and daily close at a little over eight dollars. ATPG had lost over half its value in two weeks and my call options were destroyed.

There is no need to bore you with all of the gory details, but suffice to say I was cleaned out long before President Obama opened the Gulf up for drilling again that October or November. And even though ATPG eventually made a gamely effort at rebounding into 2011, the warning shot that I did not heed on that fateful day in May was the deciding blow.

I could have salvaged a good portion of my capital if I had sold out when ATPG broke below $20, or even when I returned back home from Hawaii, and that would have been the correct thing to do. But I fell in love with the story, fell in love with the stock and my emotions and bias prevented me from jumping overboard at the first sign of trouble.

Like the Captain of the good ship ATPG, I ended up going down with the wreck as it was dashed violently against the rocks. If only I had paid heed to the old seaman’s credo, I may not have ended up in Davy Jones’ locker.

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