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Seven Years Ago Today, LJM Partners Lost 80% in Two Days

A Chicago firm that had sold stock-market insurance for twenty years lost more than 80% of its clients' money in two trading days. What it was betting on, why the bet broke, and what regulators say investors were never told.

七年前的今天，LJM Partners 两天亏掉 80%

Illustration of a person sitting at a small umbrella stand on a flat line, with a towering wave curling over them.

On February 5, 2018, the Dow fell 1,175 points, the largest one-day point drop in its history. For most investors it was a scare. For LJM Partners, a Chicago firm with more than $1 billion under management, it was the beginning of the end. Within two trading days its portfolios had lost more than 80%, and within two months the firm was gone.

A business built on quiet markets

Anthony Caine founded LJM around 1998. Its core strategy was simple to describe: sell out-of-the-money put and call options on S&P 500 futures, and collect the premiums.

In plain terms, LJM sold insurance against big market moves. In most months nothing dramatic happens, the options expire worthless, and the seller keeps the premium. The firm said it had run the strategy through extraordinary markets, including 2008. By January 2018 it managed over $1 billion across private pools and a mutual fund, the LJM Preservation and Growth Fund, which held about $812 million at the start of February.

The catch with selling insurance is that the payouts are rare but enormous. You earn small amounts for years and can give them all back in a day.

2017: too calm for comfort

Through 2017, U.S. stock market volatility sat at historically low levels. When markets are calm, insurance is cheap, so an option seller earns less for the same risk. The temptation is to sell more, or to sell closer to the current price.

According to the SEC, that is what happened. Starting in late 2017, the regulator alleges, LJM increased the risk in its portfolios to chase return targets, while telling investors the risk profile was unchanged. The CFTC's complaint adds detail: by December 2017 the portfolios had flipped from their usual bearish tilt to a consistent bet on rising prices, and the potential loss from a sharp drop combined with a volatility spike had roughly doubled compared with LJM's historical positioning.

On December 27, 2017, Caine wrote to a colleague: "I actually am a bit scared of the main portfolios. They maintain a directional bias."

The warnings kept coming. According to the SEC, in January 2018 the firm's chief risk officer raised concerns about the elevated risk, and Parvataneni said he could cut it. Doing so would have meant booking losses and, most likely, a negative first quarter. The complaint says Caine rejected that course twice and kept the risk on, to give the funds a chance at a positive quarter. About two weeks later, the market moved.

February 5, 2018

The S&P 500 fell about 4% that Monday. The VIX, Wall Street's "fear gauge," jumped from 17.31 to 37.32, its largest one-day rise since the 1987 crash. XIV, a popular exchange-traded note that bet on calm markets, lost most of its value and was shut down.

Why is a spike in volatility so dangerous for an option seller? An option's price depends on two things: how close the market is to the strike price, and how much movement traders expect. When expected movement doubles, even options that are still far from their strike become much more expensive, and LJM was short those options. Losses are marked to market every day. Positions financed with margin trigger demands for more collateral. Cutting risk means buying the options back, from a market where everyone is suddenly trying to buy the same insurance.

LJM never got to wait it out. At the close on February 5, according to the SEC, the firm's futures broker ordered all remaining positions liquidated to meet margin requirements. Across its funds, LJM lost more than $1 billion, about 80% of their value. The mutual fund closed to new money on February 7, and at the end of the month announced it would liquidate. In a letter to investors, Caine called it "an extreme outlier event" and said illiquidity had severely limited LJM's ability to reduce risk.

What investors were told

In May 2021, the SEC and CFTC sued LJM, Caine, and chief portfolio manager Anish Parvataneni. Among the allegations:

  • The worst case. LJM told advisors its estimated worst-case daily loss was 20% for the Preservation and Growth strategy, and 30–40% for its more aggressive strategies. Regulators allege the chief risk officer produced those figures by taking LJM's own worst day, rounding up, and doubling it, while the firm's internal historical scenarios, including the 1987 crash, showed losses above 40%.
  • What the firm said internally. In an April 2016 email, Caine wrote: "In extreme cases, theoretically we model to 100% loss." The CFTC says that was never disclosed to investors in writing.
  • Risk management. LJM marketed "robust" risk management built on historical stress tests. Regulators allege the portfolio managers did not use those tests and did nothing to limit exposure to volatility itself. Asked in sworn testimony whether no steps had been taken to minimize moves in volatility, Parvataneni answered: "Time will solve the problem."

The former chief risk officer settled with both agencies. Caine, Parvataneni and the two LJM entities contested the charges. In October 2024 a federal judge denied summary judgment to both sides, leaving the disputed facts for a jury. As of this writing, these are allegations, not findings.

Two lessons that outlast the case

Mean reversion is not survival. Volatility does tend to fall back after a spike. That belief was, in Parvataneni's words, "a core tenet of the strategy." But leverage and margin calls decide whether you are still holding the position when it does. A strategy can be right about the long run and still be wiped out before the long run arrives.

A worst case has to come from data, not from what sounds reassuring. If the stress test never includes the day that would end you, it is not a stress test. The honest answer to "how bad can it get?" was already in LJM's own reports.

Sources