When A Loss Isn’t A Loss

I have been asked several times about the recent case of the 20-year-old trader who committed suicide after he thought he lost hundreds of thousands of dollars trading options using the Robinhood trading app.

I have explained that the way options are tracked in an account can be extremely confusing. It can make it seem like you have a loss when you don’t, or a much bigger loss than you do simply because the trades haven’t settled or expired.

Today I want to illustrate this with an example from my Fidelity brokerage account. Several months ago I sold six put options for a renewable energy company called TerraForm Power (NSDQ: TERP). I got paid $625.85 for those options ($1.04 a share for 600 shares).

I have an obligation as a result of this trade. If the price of the stock is below $17.50 on August 21, I have to buy 600 shares at $17.50 a share (which is fine with me). That would give me an effective price of $17.50 – $1.04 = $16.46. On the day I am writing this, TerraForm shares are at $18.31.

If shares are above $17.50 on August 21, then the options expire worthless to the person who bought them. But regardless of what happens, I still get to keep the money I received for selling the option.

Thus, if the contract expired today, nothing happens. The share price is above $17.50. But the value of one option is showing up in my account today as being worth $4.90. I sold it for $1.04. So they calculated that I have a loss of $2,314.15 overall (and $2,790 today). That looks like a spectacular loss on this day of 1,860%.

In reality, I haven’t lost anything. For starters, the price they use to calculate this is the “Ask” price. If you open up the quote, you will see that the “Bid” as well as the most recent trade was actually at $0.15 and not $4.90. So that is the first problem that causes the appearance of a loss when none exists.

However, even if the $4.90 was the current trading price, it still is not a real loss. Yes, that would be the price if I tried to buy the options back and paid the ask price. And yes, if I paid $4.90 to buy back options I sold for $1.04, I would incur a big loss.

But I won’t buy them back. I will let them expire, or I will be assigned shares. Imagine if I didn’t understand this. It might look like I was down thousands of dollars on this trade, when in reality I made several hundred dollars on it. That’s how an interface can mislead you into thinking you have lost money when you haven’t.

When this option expires, I will still have $625.85 in my account for the trade. I never lost a dime. It’s possible that if I get assigned shares and they are below $17.50 that I might be initially down on the trade. (Keep in mind, though, that my effective price is $16.46 a share because I sold the options.) But the trade would not be a loss based on the current price. It’s just the way the interface shows the trade that makes it appear as if I have lost money.

This isn’t exactly what happened with the Robinhood trader who tragically took his life. My understanding is that he wasn’t down hundreds of thousands of dollars, but rather he was seeing a similar huge disconnect between what he lost and what the app showed him he lost.

It just highlights that it is important to understand what you are investing in, especially in volatile markets. Sometimes appearances can be deceiving.

Editor’s Note: In the above article, Robert Rapier has imparted valuable investing advice. Robert and the rest of our colleagues at Investing Daily continually scour the investment landscape for new opportunities.

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