Larry’s note: Welcome to Trading with Larry Benedict, the brand new free daily eletter, designed and written to help you make sense of today’s markets. I’m glad you can join us.
My name is Larry Benedict. I’ve been trading the markets for over 30 years. I got my start in 1984, working in the Chicago Board Options Exchange. From there, I moved on to manage my own $800 million hedge fund, where I had 20 profitable years in a row.
But these days, rather than just trading for billionaires, I spend a large part of my time helping regular investors make money from the markets. My goal with these essays is to give you insight on the most interesting areas of the market for traders right now. Let’s get right into it…
Today, I want to relive a special trading day early in my career… The worst crash in U.S. history: Black Monday.
We’ll never see a day like Black Monday again.
The Dow closed down almost 23% – after recovering from a more than 25% loss on the day. The largest one-day drop in its history.
There was so much volume in the market, the computers got overwhelmed and shut down. The entire market stopped for hours at a time. Traders left the floor and wandered the streets, shoulder to shoulder, without a clue of what to do.
It was complete pandemonium.
For better or worse, I don’t think we’ll ever see a day like that again. I’ll tell you why soon…
But first, let’s talk about the key events that led to the crash…
Of course, hindsight is 20/20. But we all should’ve seen that crash coming…
During the entire month of July 1987, the market only had one down day. It just kept going higher and higher every single day. Euphoria was setting in. It was a classic overextended condition. But most folks didn’t recognize it at the time.
Then, seemingly out of nowhere, it became a little more volatile in August. It didn’t seem like much to worry about at the time. The market was still up about 25% on the year.
But then September came, and with it more volatility.
And by October, leading up to the crash, volatility was really picking up…
An Especially Volatile Day
The Friday before the crash was expiration day for options. Today options expire on Mondays, Wednesdays, or Fridays. But back then, expiration day was just once for the entire month. So it was typically a pretty volatile time of the month.
And this one didn’t help much. It was a particularly big expiration day. The market got crushed and finished near the lows.
Then, we showed up for work on Monday…
It was a total crash… Completely nuts.
Back then, I was trading at Fossett Trading Company for a guy named Steve Fossett. Steve was an unbelievable investor, really successful.
On the trading floor, I was trading my own money along with his. I was short six put options and six call options. At the time, that was a big position for me.
And the market just kept going down…
So I initially sold the puts at $6, and I sold the calls at $6. I wound up buying back the puts at $60… I lost $54 per contract.
When the market goes down, generally call options go down, too. But since it was so volatile, call option premiums actually rose.
You’d think with a market going down that much, they’d be at zero. But with all the volatility, these calls went to $50. If I bought them back at that level, I would’ve been crushed. And I almost had to.
There were margin calls on that day, so investors had to close all positions.
I plainly told Fossett I didn’t want to buy the options back – because it was just ridiculous, considering the action that day… I got away with it.
And I’m glad I did.
The market went up 500 points the Tuesday after the crash. The calls I sold for $6 went from a massive loss of $50… to $1 per contract.
I’ll repeat that… The calls went down $49 with the market up 500 points.
I’m lucky I got to hang on. I didn’t do great, overall… especially with that put trade. But if I had been forced to cover those calls at $50 the day before, it would’ve blown the account to zero.
The market inefficiencies were just complete mayhem. No one knew how to react…
Like I said, there was a period where all trading activity basically stopped. When the afternoon rolled around, there were more people outside the exchange than inside. People were freaking out and walking around mesmerized.
There was no market. The exchanges were hardly functioning, if at all. If you wanted to sell a stock, you couldn’t. The system totally crashed. The game was over… the market was closed.
So, we basically stopped working in the middle of the day. And there were more people on Broad and Wall Street than I’d ever seen before.
Then on Tuesday, the market opened up, and investors got robbed. Stocks opened significantly higher than where they closed, and came pretty much all the way back to Friday’s lows.
Why We’ll Never See Black Monday Again
These days, I don’t think an event like Black Monday would be allowed to happen.
With the circuit breakers we have now, it’s basically impossible. The Federal Reserve just steps in and accommodates. The market closes automatically if things fall too far.
There would be panic, but now there are safeguards to that panic. If you stop the market from trading, people go home and clear their head. Drastic behavior just wouldn’t continue the way it used to.
After all, I believe in the mantra that “the market never does the same thing twice.”
Editor, Trading With Larry Benedict
P.S. We’re excited to hear what you think of your new eletter, Trading With Larry Benedict. Let us know at [email protected].