1. Do you mean that the low vol. environment should have been a warning to them that a high vol event was more likely to occur? 2. I'm still not sure I understand why their fund did not survive the Feb 2018 event but survived past high-vol events. The article attributes repricing of the short OTM Puts mainly to an increase in vega, however, LJM's fund did just fine during similar events in 2008, 2011 and 2015. See equity curve below:
The problem in feb was that only the deep downside puts got bid. Any risk management assumption they probably held (likely gamma hedge) did not work because the markets weren’t down enough. It was extremely isolated. I did well that day because I was long Spx vol that went up but none of my short risk premise trades went down.
They can’t reduce their position even if vol was low. No client is going to pay them to hold cash even if that’s the right position. That’s the difficult part of being a fund manager. They have to put money to work or they will be redempted.
The reason was insane options pricing. Look at my previous post. Monday night into Tuesday S&p put expiring in 4 day 1000 points away was being sold at 9. This never happened before, and if Vix was trading over night it was probably like 150.
You keep saying this but it's absolutely not true. I've told this story several times about a guy at my old prop firm that sold teeny puts in the SPX 700 to 800 handles OTM. I got on the phone with him and warned him, that if we should have a sharp downside move and those puts went $5 or $10 wide, I would go into his account and start lifting offers. He assured me that he backtested this over 20 years and no such move ever took place. I tried to explain to him the issue is not the move itself, but the lack of liquidity. Sure enough 3 months later a streetful of Greeks were throwing rocks at the police on live CNBC coverage. That afternoon we had the flash crash. The 700, 800 and 900 strike puts he sold for .10 went $20 offer. I was a man of my word. I blew out his account. I didn't hit the $20 offers. But I paid $10 all the way back down to $3. Still blew out 100% of his capital. I told him this is exactly what would happen. Traders never listen to those with more experience. They think they have it all figured out. So please stop saying this has never happened before. It has and it will happen again. Because that's exactly what markets do, rinse and repeat...over and over again. The moves are always the same, only the names of the victims ever change.
Any idea as it why only OTM puts were bid up? This points to a more technical/systemic issue rather than a move driven by fear that would take place across the skew, or?
As of Jan 31, 2018 LJM had the following Put positions: - short Puts from 2,160 - 2,680 (~46 mill) - long Puts from 2,665 - 2,805 (~22 mill) (https://www.sec.gov/Archives/edgar/data/1552947/000158064218001814/ljmnq.htm) So it appears they were hedging with a classic 2:1 ratio put spread. But since the closer to the money Puts did not increase sufficiently in value vs. the OTM puts, the fund could not benefit from the profit hump that is characteristic of the ratio spread, correct?
Right, the profit curve curves up over time, however it does seem that this is what LJM betting on for protection, or?