The Rarest Collapse In Stock Market History

In April of 2020, something that had never happened in the history of finance... happened. Oil prices are collapsing. Tumbling more than 300%. I don't think anyone was predicting this. Minus $36 a barrel. In the span of a few minutes, it broke everything the world knew about markets, destroyed multi-billion dollar investment funds and made a group of friends in their 20s $660 million richer. Minus $36 a barrel. As I watched this unfolding live, a friend sent me a message. It sounds like a stupid question, but was it really any more irrational than what I was seeing on my TV? Contracts that obligated sellers to pay for someone to take their oil were going like hotcakes. A lot of people have been joking that they should run out to the petrol station and fill up their car for free or be paid to fill up their car. Well, that's not actually what's happening, but it's fairly close to that, at least in idea. There is an explanation for why exactly this took place. And it's a story best told from the perspective of the traders who predicted that the impossible was possible. The group that found a way to sell oil for a profit and then to get paid to buy it right back. It's 2016 and veteran oil and gas trader Paul Commons is operating a small trading group that he started in the early 2000s. The group includes another veteran trader, Chris Rose, Aristos Dimitrius and an amateur trader, Elliot Pickering, who still lived with his mother at the time. They operate as an offshoot of Tower Trading Group, one of the largest prop trading firms in England, but each of them traded independently with their own brokerage accounts. At least on paper, they were independent. In practice, they often made similar bets, buying the same securities and selling the same securities at the same time. But 2016 was going to be their last year under the Tower Trading Group. Paul Commons quit the firm to start his own, Vega Capital London, taking Rose, Dimitrius and Pickering with him. By 2020, the group included other new additions, notably Commons' son George and Connor Younger, who was just 22 years old at the time. And in early 2020, a once-in-a-lifetime opportunity appeared. The price of West Texas Intermediate crude oil started the year around $60 a barrel and had drifted into the 50s by February. But in March, the price decline accelerated. As COVID spread around the globe, airlines began taking much fewer flights, and either by choice or government mandates, there were far fewer people driving on the roads. All of a sudden, there was a dramatic drop in demand for oil. Between March 13 and May 8, the US weekly gross refinery inputs fell 20% to 13.1 million barrels a day. Oil producers attempted to cut back their production to match the new demand level. After negotiations with Russia and Saudi Arabia, the US agreed to reduce production by 10%. But it wasn't nearly enough, and with supply still vastly above demand, the price of oil collapsed into the 20s. But the trading opportunity that Paul Commons saw goes far beyond just trading at a time of higher volatility. He began to realize that the oil market was primed for a historic collapse. Traders like Commons can speculate on the price movements of oil by using a financial instrument called a futures contract. It's a legal agreement that mandates the purchase or sale of 1,000 barrels of oil on a specific date in the future. There's one of these contracts for every month of the year, and you can choose to be on the buy or sell side of an oil transaction. That's called going long or short. So for example, you can take a long position in the May 2020 contract at a price of $35 per barrel. The settlement date for that contract is the 21st of April, so you're agreeing to buy 1,000 barrels per contract at $35 each on that date. But Commons wanted to bet on the price of oil declining, which you can also do with futures contracts by taking the short side of the contract. You'd be agreeing to sell oil at a fixed price on a specific day in the future. So if the price was to decline, you could buy oil at the new lower price and sell it at the higher fixed price on your contract. Of course, in practice, you're not actually involved in the buying and selling of physical oil. Before the settlement date, you would just take a long position that's equal to the size of your short position. So you'd now be obligated to both buy and sell 1,000 barrels of oil, so the two contracts would just cancel each other out, and your profit would be the price difference between the two contracts. But an even better outcome would be if the price went negative. When you went to close your position by going long, you'd essentially be agreeing to be paid to buy oil. Your short and long positions still cancel each other out. One of your contracts says you get paid to sell oil, and the other says you get paid to buy oil. The practical meaning of a negative oil price is that oil is no longer an asset. It's a liability. Commons and some of the other traders at Vega Capital watched as the price of oil continued to fall in April. The oil price quoted on TV is the futures contract with the nearest settlement date. At the time, this was the May WTI contract. On the 21st of April, whoever was holding the contracts would be obligated to buy or sell physical barrels of oil. As the date approached, the price just kept falling, sinking to just $18 on the 17th when trading closed. It would reopen on Sunday at 6pm New York time, where the May contract would be just a few days away from settlement. Commons and some of the others at Vega Capital prepared to trade the event. They each operated independently out of their homes in Essex, and at about 11pm local time, the market reopened. The strategy they used had two key steps. The first was to buy a ton of TAS contracts. TAS stands for Trading at Settlement. It means they were agreeing to buy oil at whatever price the WTI futures were at when trading closed that day. For the Essex traders, they were hoping for the price of oil to fall, and to finish the day lower than where it started. The second stage would take place throughout the day. They would slowly go short on WTI futures, acquiring chunks of contracts that obligated them to sell oil. If this all went to plan, it would look something like this. The price of oil starts at around $20 a barrel. They buy 100 TAS contracts, effectively agreeing to buy 100,000 barrels of oil at whatever the price is at at the end of the day. Then, as the price declines throughout the day, they go short on 20 contracts at a time, agreeing to sell 20,000 barrels at $18 a barrel, 20,000 at $16, another 20,000 at $14, $12, and finally $10 a barrel. The outcome being that they've now agreed to both buy and sell 100,000 barrels of oil, so those contracts cancel each other out, they have no obligation to buy or sell any oil, and the profit is the difference between the buy and sell prices. Sounds easy enough, but it's actually incredibly risky. If the price rose instead, they could be on the hook for a huge payment. But Commons was confident that the price would decline, because he saw something that no one else was paying attention to. Trading for WTI futures opened, and the Essex traders immediately began buying a truckload of TAS contracts. One of the biggest sellers on the other side of this trade was China's crude oil treasure fund. The price of oil at the time had already fallen from more than $60 a barrel to $18 in a couple of months, so the fund was betting that the price would reverse course, allowing them to sell at a higher price when the trading session ended. And even if the price continued to fall, they believed that their losses were limited, because the price couldn't possibly go negative, right? Well, after securing their TAS contracts, the price of oil continues to fall, from $18 at market open to around $10 by 12pm New York time. Commons and some of the others begin going short WTI futures contracts in batches, and the price just kept falling. For the next two hours, the decline accelerated, barely sitting above $0 by 2.07pm. And at 2.08pm, for the first time ever, the price of oil was negative. This had never happened in the history of markets, and it wasn't just investors who were caught off guard. Interactive Brokers, one of the biggest platforms for trading these contracts, didn't even allow you to enter a negative price as a bid on their software. I'm not kidding, there's a whole lawsuit about it that I'll talk about later. But negative prices were not only possible, given the circumstances on the 20th of April, they were actually a certainty, and it all has to do with settlement. On the 21st, anyone with long positions in the contracts is obligated to buy physical oil. For WTI contracts, this means taking delivery of oil at the facilities in Cushing, Oklahoma. You can't just say, please deliver these oil barrels to my house, you have to store the oil in tanks or in pipelines connected at Cushing. Or in other words, you'd need to buy storage space from a midstream company who owns tanks or a pipeline there. In total, there's room for about 76 million barrels, and by the 17th of April, it was already about 80% full. And the remaining space was already leased out to oil buyers who needed the space. So all of the facilities, the only place you can actually take delivery of WTI oil, was full. There's a few reasons why this happened. Firstly, the COVID shock meant that oil was coming in faster from producers drilling than it was leaving to go to refineries to make diesel and petrol. Secondly, the June oil futures were priced significantly higher than May, which is a situation called contango. If you're a midstream firm with tanks at Cushing, storing oil for the next month is highly profitable. You would simply buy in May at a fixed price, and then sell in June at a higher fixed price. So demand for the limited storage surged, and so did the price, from $0.20 to $0.30 per barrel per month in January, to $0.50 in late March and April. And you might think $0.50 sounds great, since you're literally buying oil for free. Overall, that sounds like a pretty good deal. And you're right. It would be if there was any space. That price for storage is really meaningless, because no one had a single barrel's worth of space in their tanks to sell. And that's precisely what made negative oil prices not only possible, but a guarantee. Anyone that was still holding long contracts, would typically be forced to take delivery of that oil at Cushing. But with there being no space, they were instead forced to close their positions, regardless of the price. You can think of the market for oil futures like a scale. On one side, you have the buyers of long contracts, and on the other side, the buyers of short contracts. And on both sides, there are two types of participants. You have the hedgers who buy contracts with the intention of actually using them. On the long side, that would be oil refiners and petrochemical companies, and on the short side, that would be producers who drill and pump oil. And then there's speculators, traders who just want to bet on the price rising or falling. At the start of the 20th of April, the scales kind of looked like this. Short hedgers, the oil producers, needed to get rid of their oil, so they all stayed short. Long hedgers, like oil refiners, already had too much oil due to lower demand, so there was an imbalance. And the speculators knew this, so their trades also reflected this. So of course, the price continues to slide throughout the day. But in the last couple of hours, the scales basically broke. Short hedgers stayed short, they wanted to actually sell their oil. Long hedgers were also going short because they had too much oil. The long speculators also all went short, because they had to close their positions before settlement. Remember, there's no space at Cushing, so any traders with long contracts were literally forced to buy short contracts at the end of the day. And the short speculators could stay short until the very last second. There was such a dramatic mismatch between the number of buyers on the short and long sides, that many traders were willing to pay anything just to get out. After tipping negative at 2.08pm, there was less than 30 minutes of trading left for the TAS contracts. The desperation from traders who still held long positions increased. They needed to close their positions by going short, and they needed to do it right now. Over the next 28 minutes, the price plunged, closing the trading session at negative $37.63. In that final half an hour, the 9 Vega Capital traders were the biggest sellers of WTI futures. They successfully exited their positions, and pulled off one of the greatest trades of all time. Bloomberg reported on 9 of the traders from Vega Capital, who made a combined $660 million. And the Daily Mail UK reported that those 9 and 2 other traders made £570 million, about $700 million in total. Elliot Pickering was the biggest known winner, making £81 million. Paul Commons made £25 million. Chris Rose made £73.3 million. But by far the most astounding of all was Connor Younger, who was just 22 years old at the time, making a staggering £81.5 million. More than $100 million, and most of that was earned in just 20 minutes of trading. I also just want to quickly highlight how the price going negative absolutely supercharged their profits. That example that I gave earlier, while using the same numbers, with a trader risking the exact same amount of money, $20 falling to negative $37 would have skyrocketed profits to $5.3 million. Their TAS contracts that settled at minus $37, meant that instead of having to pay $10 per barrel for oil, they were actually paid $3.7 million. An unthinkable scenario, getting paid to sell oil, and then getting paid even more to buy it right back. As I'm sure you can imagine, for the traders on the other side of this, it was devastating. China's treasure fund, which sold lots of those TAS contracts to the Essex traders, lost everything. Oil that they had earlier paid to buy, they now had to pay $37 per barrel to sell. It'd kind of be like if you spent all of your money to buy a $1 million house, and then 24 hours later, you were forced to sell it and pay another $4 million. Interactive Brokers lost $100 million when the price went negative, because their software wasn't equipped to handle negative prices. And Bloomberg also reported on a trader from Toronto who lost $9 million. He started buying heavily at $3 a barrel, with the assumption that negative prices were impossible. It's easy to look back in hindsight and think that this was easy money, but the reality is that the trade was an insane gamble on a genuinely once-in-a-millennium event. Subscribe if you enjoyed, and consider checking out one of these videos next. Cheers.