Like I said, all rules and models went out of the window that night. It was not the plunge (it was not that big) that was the issue, it was pricing of options. No one ever saw anything like this. Another weird thing was that the spreads were tight like within 5 points. For example, during August of 2015, the spreads were 10 to 20 points but the prices were rational. Also, last Friday when the market sold off hard and almost hit Tuesday night low, option prices were normal, way above what took place Tuesday night. One had to be in it trading to fully comprehend.
They were trying to hedge with futures, which usually works but that night options were raising a lot faster that futures shorts were making. Another oddity. It was definitely a night to remember.
As always, the problem is not the strategy. The problem is leverage. It is sad that those supposedly highly educated and trained fund managers still have no idea about the most important aspect of trading - position sizing.
People are simply human after all; Your reply made me think of the bible. Free Will: Good vs Evil. Temptation surrounds us 24/7. Follow the straight path, or stray....money/greed...will you bend your morals and values and ideals for it. Loyal to your wife/girlfriend -- or cheat. Stick to a healthy diet/exercise routine...or watch TV and eat fried chicken. etc etc decisions that surrounds us everyday. All the great Wall St/trading bomb stories could have been prevented...if they were bible readers, and followers of it. Keep things kosher and proper in your professional and personal life. 2018...High-Five`, KK
Well, those quotes are very helpful in life in general, not only trading. But when you give your hard earned money to professionals, you still expect better. Drawdowns are part of trading, they are inevitable. But blowing up the accounts in 2 days is a completely different story. I cannot even imagine what kind of leverage they had to implement to be blown up like this after 5-7% correction.
You do not really comprehend what went on that night. LJM survived 2008, and that speaks highly of them. It was not the severity of the move (was not so bad) nor the position sizing that was the issue (no idea what it was, just assuming) it was a totally insane pricing of options that no one ever saw before. S&P 500 put expiring in 4 days 1000 points away was trading at 9. That is a very definition is risk free money if you were in position to capitalize on it. How imagine the price of the options few months away and let’s say 10 percent away from the market.
Obviously none of us knows exactly what happened. However, I did some simulations., selling options on different strikes and expirations. With proper position sizing, they would be down 10-15%, not 50%, even with those crazy prices. The only explanation is excessive leverage and margin calls that came as a result.
Which strikes did you assume? I'm wondering if most of their loss is due to convexity, as RedDuke mentioned the "insane" prices we both observed between Feb 5 and 6. It is one thing to sell a put for $100 and see it go to $400, but it is a little different if you sell 50 puts for $2 and they go to $50 and you can't delta hedge on the way down, which I believe is something they wrote in their recent letter. As spot moves down, these $2 puts have more and more vega and your delta hedge won't help much. My guess is that they had excessive leverage for implied vols they did not anticipate.
I tried few scenarios. Deltas from 2 to 20. We had few short volatility positions too that day. In fact our whole Steady Condors portfolio is short vega and short gamma. The whole portfolio was down 3-4% that day, with all the crazy prices. Why can't you hedge on the way down? This is exactly what we did.
Were your positions naked or limited? That makes a big difference with implied volatilities. I meant to say you can't hedge the implied vol with delta, and sell futures fast enough because it is too jumpy. Sorry for the confusion.