How to best prepare for black swan & other catastrophic events

Quote from Worldcrusher:


1.) be hedged 50/50 long and short, because ANY directional exposure (even 1%) could be enough to temporarily wipe out a fund
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This obviously very much depends on the leverage you employ. The problem with written options is that the implied leverage is usually way to big if something really bad happens, otherwise the returns are just to low. Also your leverage increases when the market goes the wrong way, an undesirable characteristic.

If your strategy cannot withstand a 1987 style crash forget about it. Very few option selling programs pass that filter.
 
Get Charles Cottle's book Options Trading - The Hiddel Reality. He tells you what options marketmakers do to protect themselves from unforseen gigantic price shocks: Get long the wings!

"Wings" is a term nicked from options butterflies and condors, meaning the far Far FAR out of the money puts and calls. They are cheap, but not as cheap as you'd wish, because everybody wants them and the price is bid up. Why does everybody want them? For the same reason you do: insurance against catastrophic moves!

Buying insurance reduces returns, just as you'd expect. However, despite this obvious drawback, every few years some bozo comes along and offers a Profit From Catastrophe hedge fund whose only strategy is to buy very deep out of the money puts and calls. The fund treads water waiting for huge price shocks to come along, which will (it is hoped) make their investors tremendous returns. These funds bleed money every month, paying insurance premiums (re-buying options as they expire), and eventually they shut down with considerably less fanfare than accompanied their initial offering.
 
After reading these posts and learning the various methods traders are using to protect their funds against sudden market declines, I started to wonder if there is a company out there that insures a fund against such an occurrence? I mean, you can insure your house, your business, your car, your life, why not your fund?

Theoretically, they might charge a premium and would have an established deductible (loss the fund might take before the policy would take effect). Is there such a thing? And if not, why not?

Thanks,
Daryl
 
Quote from Worldcrusher:

After reading these posts and learning the various methods traders are using to protect their funds against sudden market declines, I started to wonder if there is a company out there that insures a fund against such an occurrence? I mean, you can insure your house, your business, your car, your life, why not your fund?

Theoretically, they might charge a premium and would have an established deductible (loss the fund might take before the policy would take effect). Is there such a thing? And if not, why not?

Thanks,
Daryl
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"insurance" - that is what futures/forex is for. Hedging. That is what airlines, food companies and many others do. They hedge against their purchases to lock in a price.

Your question is like asking of you can take out an insurance policy to safeguard your life insurance policy.

And frankly, if a catastrophic event occurred, there would be doubts that such as company would be able to back up your "insurance" - that is what is going on now in this subprime crisis. Some of the companies involved in insuring against such a problem, may not have the funds to cover their liabilities.
 
Quote from Worldcrusher:

After reading these posts and learning the various methods traders are using to protect their funds against sudden market declines, I started to wonder if there is a company out there that insures a fund against such an occurrence? I mean, you can insure your house, your business, your car, your life, why not your fund?

Theoretically, they might charge a premium and would have an established deductible (loss the fund might take before the policy would take effect). Is there such a thing? And if not, why not?

Thanks,
Daryl
More...

There are many insured funds out there. The insurance is very expensive, probably even more so for a premium seller.
A premium seller is selling insurance in the first place so if he buys fund insurance, then he's buying reinsurance.
 
Black swans are only really dangerous if you are short premium, or make unhedged directional bets using leverage. You can minimise those risks by hedging with deep OTM options, or having offsetting positions.

If you are long-only, then just show them a chart of Sep 11th and say "Expect this to happen once every 10 years or so". A 10% one-day hit is no big deal if it only happens each time someone does an Osama. The S&P can lose that in a week, easily, without any black swan event at all.

I'd not try to deny risk, but simply explain what plans you have to make sure you might lose 10% on a 9/11 style event, but not 30%+, let alone a total wipeout.
 
Quote from Cutten:

Black swans are only really dangerous if you are short premium, or make unhedged directional bets using leverage. You can minimise those risks by hedging with deep OTM options, or having offsetting positions.

If you are long-only, then just show them a chart of Sep 11th and say "Expect this to happen once every 10 years or so". A 10% one-day hit is no big deal if it only happens each time someone does an Osama. The S&P can lose that in a week, easily, without any black swan event at all.

I'd not try to deny risk, but simply explain what plans you have to make sure you might lose 10% on a 9/11 style event, but not 30%+, let alone a total wipeout.
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Cutten,


Assuming you trade S&P futures, what maximum leverage you could use when you want to be fully protected with OTM options ?
Any idea what it would cost you in % in function of the used leverage ?
How to find out what max leverage could be used with other products ?
 
Aside from black swans caused by geo-political events like 9/11, most big down days happen during severe bear markets. The most notable exception I can think of off the top of my head was 1987.

This is why we haven't had any daily drop of >4% in the last few years. We've been in a big bull market.

The day after MLK was going to be that big down day we've been waiting for, but the Fed spared the market.
 
Might be a little more likely occurrence than you think! The current global population of the Black Swan is estimated to be up to 500,000 individuals. Hence all this discussion.

http://en.wikipedia.org/wiki/Image:Black_Swans_Canberra.jpg
Quote from eraci:

To better prepare for a black swan, I'd pay top dollars for an advanced prosumer DSLR camera - a black swan is rare luck to run into :) I'll take a full 4GB memory card load of photos...

Not sure about other catastrophic events...
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