BIG BANG Insurance

Discussion in 'Trading' started by vetten, Apr 7, 2007.

  1. vetten


    hello folks,

    I would like to protect my stock holding against any massive drop in price, that happens once every 5-7 years.
    To put in a short portfolio to balance out my long portfolio is too time consuming, takes out too much of my trading capital and is sometimes too costly.

    An out of the money put is too costly to put on for 5-7 years.

    So I`m thinking along the lines of placing a sell stop about 150/200 points away from the DOW with futures, options or whatever that is best.
    It can ofcourse also be an other index or way of hedging.

    For that reason I think it would be good to put in place a sell stop in a market, just as an insurance for that BIG BANG.

    When that happens, dont try to ring your broker or place an order online. Last February I couldn`t get through to my broker and my orders online took 2 hours to be placed in the market!

    So I can have an sell stop order on my broker`s platform before the BIG BANG, but how long would it take to be filled if at all when it happens? There might be communication problems between broker and exchange. Nothing is sure because of the overload.

    Is there any market where sell stop orders are native?

    Well I like to hear your thoughts on this subject.

  2. (1) If you're a long-term investor, don't bother with it. (2) As you said, in an "avalanche scenario", your stop-order could be filled hundreds of points away from your actual stop-price. (3) If you feel bearish, you should be willing to lighten up your portfolio now instead of waiting for confirmation of your bearishness. Trust your instincts instead of the market.
  3. vetten - I've never placed an order that far away on a futures platform, but you will want to ask the broker how they and the exchange will handle that order just sitting out there. Again, I do not know the specifics, so you just want to double check to ensure that it does not get canceled due to it being so far away from the market and/or inactivity. Keep in mind as well that you will have to fund the futures account with at least 5 grand at most firms and depending on how many contracts you need to trade, that could require a decent amount of cash just sitting at the future firm for the 'what if' scenario. You could plop the funds in T-bills, but that's only going to earn so much. So the question then becomes what opportunity is lost by having some of your funds tied up in a futures account that is only going to be used every few years.

    As for the idea itself, you can either view a big drop as a reason to have a strategy like this in place or view it as a reason to add to your existing positions. Just depends on if you are long-term investor or looking for a quick buck here and there. An investor should welcome drops as a way to add to your positions at low prices.
  4. I don't know about stops, but trades I placed interactively on IB on Feb 27 got filled promptly. There was some slippage, a point or so, on some of my market orders on ES futures, but given the whipsaw action that day I didn't mind.

    Out of curiosity, what were you buying that took 2 hours to fill? Even the QQQ option straddles I bought on Sep 17, 2001, which were filled manually by Schwab on a crazy day, only took around 10 or 15 minutes to get filled.
  5. vetten


    thanks nazzdack for your reply

    1. no I`m not a long-term investor, but still my trading stock is worth around $ 450,000 and being consistently profitable since September last year I start thinking about how to protect my trading capital in a market crash of say -35%.

    2. with my stop sell order I would already be away from the last price to the tune of 150-200 points and to get filled at 200 points below that is not impossible but unlikely.
    but even that is far better than doing nothing. in that scenario I would sell short at say 12,100 from 12,500 (last price) and follow it down all the way to 8,125 (-35%)
    not bad in anybody`s book I would think!

    3. the sad thing is I dont know a bear market from a bull market, so I`m never bearish or bullish, I just trade!
    as an ex-accountant my gut feelings are not exactly honed to a sharp edge.

    would like to know the signs though that are common in all those crashes...........
    are there any threads on this subject?
  6. vetten


    thanks browns,

    never traded futures, so wouldn`t have a clue of what is possible.
    wouldn`t be too difficult though to put an stop sell
    order in 150-200 points away from the present price to see if the order is accepted?!?

    so if I want to protect a $ 450,000 long trading portfolio and taking in consideration that I`m already down by the time the sell order kicks in, I would have to short around $ 475,000 in contracts.
    how many contracts would that be?

    so you`re right a certain amount of capital will be tied up (thanks for the T-bills idea) , but its still better than doing all the work for a short portfolio or buying a put, with both probably costing money and the future order only tying up money.

    or is there a better way?

    thanks browns
  7. vetten


    hi loufah,

    I am trading stocks on the Ozzie share market and the broker`s platforms are way behind the US.
    I also got an IB account so I can compare the 2.

    Very expensive to trade in Ozzie: $25-33 per trade and if you want such an "exclusive" tool as a stop loss you pay $ 10-$15 more! You have to ring in for that!

    Mostly they have STP (straight through processing) but they have filters in place, whatever that means. Its then done manually I think.
    well my orders always seem to get filtered........I see it on my screen: it goes from accepted, to processing, to open in market.

    And on 28th of February here in Ozzie all hell broke lose and it took at least two hours to process my orders.
    Is it any wonder I`m looking for protection? And I sure wont put that stop sell order in my Ozzie account:(
  8. lindq


    You'll be liquidating at precisely the time you should be buying.

  9. vetten - I honestly do not know the 'best' way to calculate how many contracts you want to sell at a certain level. The calculation will need to take into account how much insurance/protection you actually want, then consider what fill price on the futures contract you will/might get and where you plan to exit that futures position. Just entering the futures trade is only one part of the consideration.

    I really don't think there is a perfect answer. Either you will want more futures contracts available to protect more of the long portfolio, and in turn have more money tied up in a futures account; or you simply want some sort of protection so more money is working for you.

    And then you need to run comparisons to see what 'costs' you the most - simply buying some puts or bear ETF's or selling futures (and taking into account the amount of capital tied up).

    Good luck and let us know what you decide to do.
  10. vetten


    thanks browns

    ofcourse there`s no perfect answer, but that doesn`t mean to give up on it.
    just to get quite close is good enough to me

    so I do know the figure I want to cover = $ 475,000
    so I take the futures contract furthest out, subtract 200 points from that contract and calculate the value of that contract at that point.
    divide $ 475,000 by the value of that contract and I will know how many contracts to short sell at 200 points below the index.

    the fill price might be little different, but so what, at least I`ll be covered for a very high percentage or maybe even overcovered!
    and ofcourse entering is only part of the consideration, but I got to start somewhere and the start of every journey is the first step.

    I think somebody calculated that to buy a put costs about 3% per year for 85% coverage so that would be $ 13,500 for me per year + a loss of 15% on my portfolio = $67,500
    Assuming a crash takes place every 7 years my total cost would be $ 13,500 + $ 67,500 : 7 = $ 23,140 per year
    This is a loss.

    With futures it only will be an opportunity loss.
    Say if I make 50% per year on my trading account and get 4% on the T-bills, thats 46% opportunity loss over the deposit I have to make for that stop sell order.
    How high is that deposit? So if a contract is worth say $ 70,000 and I place an order, do I deposit around 5% to pay for the initial margin?

    thanks browns
    #10     Apr 9, 2007