On the topic of Black Swans, I can think of one experience that would qualify. At the very least, it was an event that I never thought was even possible.

Picture a scene… it’s early 2002 and Jason is learning about options and has been trading options for about three months now. He’s made many of the rookie mistakes, but learned a lot along the way. One morning while at work, he logs into his brokerage account to dump an option that wasn’t performing (he’s an option buyer and was long 1 out of the money call). The day before the option was trading at a bid/ask spread of $0.50/$0.60, yet this morning when he logs in, he sees the price on his screen is at $3.50/$3.60.

Ma-neh-wah?!?! Not one to ignore the possibility of a recent buyout announcement (or some similar news) of the underlying security, Jason sees this as manna from heaven. He sold immediately at $3.50 and even saw the cash credited to his account.

Now… the black swan is waiting in the background, waiting to strut past our beaming protagonist who thinks he just pocketed $300 in unexpected profits. The important thing is that I was still learning about options, and getting out of this trading position at $3.50 was neither in my plan, nor wholly expected. As such, it didn’t bring the havoc that a black swan would typically cause to someone who based his plan and leverage on only ever seeing white swans up until now…

Anyway, back to the story. Return to scene… Jason smiles to himself… if not for being smart on this particular trade, then for being lucky enough to sell that morning. He returned faithfully to his work and didn’t think too much more about the event.

About two hours later, Jason’s cell phone rings. It’s his broker. “That’s odd,” he thinks to himself, “they’ve never called to congratulate me about a profitable trade before…”

The broker says, “We got your sell on the 1 call this morning and have to bust the trade. The other party to the transaction got a bad quote from the NYSE and his prices were wrong. The market maker is busting the trade.”

What? They can do that? [Enter black swan, strutting around behind Jason’s desk…]
A thousand smart-ass comments come to mind immediately… Who do I call when I end up with an option I overpaid for and don’t want? How can I arbitrarily cancel orders hours after they are completed? Can I just make losses disappear with this trick? Can I reverse any order by claiming “a bad quote”?

After a conversation with the broker, the picture became a little clearer. The other side of the transaction was one of the very large market participants who effectively make the market in several thousand options. They get streaming data from the NYSE, plug in the latest price to some formulas, and their bids and offers for the options get put into the market. This other party was obviously a big participant in the market, so when they barked about an unfair transaction, the representatives for the market listened.

So, in the end Jason has his 1 call contract back, no $300 in unearned profits, and one heck of a story.

[End Scene]

Now, should I have known that trades can be busted after the fact? Probably… (it is a rule of the exchanges after all…) but I certainly never expected it, nor did I think that it was even possible.

This event was hardly a crash of ’87 type of black swan, but it reminded me that even what seems like an unarguable reality can be taken away from you, even retroactively.
How could the bid/ask for a market be wrong? How can a completed trade be cancelled?
There are ways that even the most improbable things can (and will) happen.