Before the advent of 24 hour trading, markets use to close overnight. Gap risk means if you have an open position, your position can be subject to gaps so if something good/bad happens while markets are closed you won't be able to close or hedge . This means you are either very rich or very poor the next day. With 24 hour trading, you SOMEWHAT mitigate gap risk because , you might be able to hit a bid in the after hours to close or hedge your position. That being said, having bids out there to hit does not mean you've hedged your black swan position. What if the bids are 20 handles below. Your Pnl is basically toast. So for all intents and purposes you have gap risk. Hope this clarifies a little.
rdemyan, what he's saying is the same thing i was talking about when i was debating the validity of the vix hedge. the bids will either widen or will be so thin that the effectiveness of the hedge will be significantly reduced. Think about this for a sec, who will be jumping on the bandwagon when the black swan happens? People will be jumping in trying to profit from the downside as others try to get out and hedge losses. So what will that do to the bids? Who will stand in line and support them? I think u will be able to get into futures but not until its too late or before the initial drop has happened and things settle for a minute. By then it will probably be too late as you will be at max loss or near by and any hedging from that point with futures will be just another speculative trade.
Okay. But what if I have a long put option on the SPX. A black swan happens overnight and the next morning my put is 20 handles ITM. Is your opinion that I wouldn't be able to get intrinsic value for that option if I tried to sell it?
I do think if you have a bad downside exposure a vix hedge might be the only thing that would work. As i've said, if your position would suffer from a mkt meltdown , you'd be hard pressed to equlize your long deltas thru the emini futures bec there would be very thin bids to hit. But if you are long vix futures in conjunction with your open position, it might help. The issue there is the deltas. I wouldnot know how many contracts to hedge my open positions against.
Congrats if that happens to you.. In that situation, you definitely will be able to sell your put close to intrinsic. However , realistically if an event happens which causes such discontinuity, the emni mkt would probably be 1 -2 handles wide so the bid/offer of the put would be wide as well. You'd prob be better off buying the underlying and exercising the put.Unless of course it is European exercise. OR you can sell another option that is closer to fair value and lock in a vertical for free.
I remembered that I had the attached file on my computer. It's the 1 day % change after a market shock event. I think it was posted here before (by Ryan??). I'm not sure which index they are referring to in the chart. I guess it's the SPX since the source is Standard and Poors. Of the events listed, 9/11 was the worst with almost a 5% drop. At today's levels, that would wipe out a 60 pt cushion between a short bull put strike and the underlying SPX (the day before).
I think the perception about the E-minis is not correct. The E-minis are quite liquid and spreads are 1 tick. It is electronically traded and if the ca ca hit the fan the futures would move fast but you will have no probem getting a market order filled at whatever the bid is at that moment and the spreads will stay fairly tight. On normal days, ES does about 800,000 contracts a day on average and on really voltile days it is well over 1,000,000 contracts of volume. Getting an order of 50 or 100 contracts filled is not a tall order given that liquidity. I have seen the ES move 5 handles quickly on a post-FED announcement and the spreads stay 1 tick apart at all times even if it is dropping 2 points in about 5 seconds. The point is that if a Black Swan event occurs the market is not going to dip 40 points and come back. It is going to fall fast and keep doing so for some time. If the news hits during trading hours and the futures are crashing you (well me since I am in front of the computer) will see it and if I have short strikes in trouble I can short a 100 lot position quicky and provide a PARTIAL hedge and reduce my losses. Each point would be worth $5,000 and if I miss the first 30 points and ride the last 20, I can make $100,000 in futures and produce a mini profit hedge to offset a part of potential losses. This is an emergency measure. The risks are: 1. Not being in front of the computer when the caca hits the fan and missing the whole crash; and 2. Shorting finally at the bottom and watching the market move sharply back higher. To mitigate this risk I probably would not do 100 contracts unless it was really a bad bad event. So it is not a perfect hedge and again I will only use it when the market is falling hard and something bad happened and no clue as to when it will stop. But in all honesty I do not have the perfect hedge for an unexpected event except to not be 100% in the position. Otherwise I am working on using VIX Calls and ES futures to stop the bleeding and get out. Since Black Swans are very rare, all I need to do is survive. Then I can just keep trading and make it back eventually as opposed to those who blow up and are never heard from again.
Remember that was a 1 day change in the market, it was not a gap to open down 5%. That is a little different. 1 week after 9/11 the market did not open down 5%. I do not remember the open price but it opened and just kept falling. So you would have missed the first move but would have had time to add the short futures, in my specific case, and create a partial hedge and deal with your position. There would have been a loss but it would have been mitigated slightly through the hedge. Also not being 100% in the position is the ultimate hedge naturally. My advice is that if a Black Swan keeps you up at night and scares you then you are either putting too much capital into this position or puts are not your thing. I do not fear that which I do not have control of but have confidence in that which I can control- portfolio allocation and whatever partial hedges I can add to reduce the bleeding. Since I am guaranteed to survive I know I can trade back while many will take fatal losses. Confidence is what keeps me in my positions and hedges and lets me sleep at night
Coach: I think your advice is correct for me. This month, for example, I'm two to one bear calls to bull puts. Part of the reason I seem like a "nervous nelly" is because I have a significant loss from before to make up. One more bad event (like a black swan) and I could be out of the game for good. So mostly for that reason, I think I'm going to go all bear calls until I feel I can handle the put risk with shorting futures. I'd like your advice on the following. With ToS I can elect to trade futures. So I'm thinking about adding this option to my account and then trading futures in the play account for a number of months until I feel comfortable with them. This way I can try different things, see how it affects my margin, etc and get used to how futures are traded. Do you think ToS is a decent platform for this what I'm suggesting.
I agree with some of your points specially the optimizing of position size to be able to sleep. However, there might be better ways to hedge that for it does not make sense to hedge a limited risk position thru the use of potentially unlimited loss positions. You'd be better off buying wing puts . The manner in which you describe trying to get out of this hole by overhedging futures and making another 100k in the process is nothing but doubling down or Martingale?