Should we self-insure?

TGregg, professional traders can hedge themselves with protective options positions, such as puts, for the worst-case scenario. Some always do this, others just in the more uncertain times. Yes, it costs money, but it's a good insurance against death.

A trader friend of mine from the UK was trading the FTSE on 9/11. Suddenly, the bid just disappeared. Well, he thought "WTF?", switched on TV and saw these jumbos crashing into the world's biggest (inhabited) buildings.

Well, he was short, and while trying all along during the fall (what, was it 600 points straight?) to get out, he couldn't cover, until finally some buyers came up hundreds of points below. The result doesn't require much imagination. He couldn't deal with the morals of having made money from misery and error, so the proceeds, a very large amount of money, were donated to the 9/11 Fund.

Quite a moving story I thought.

Particularly the feeling of helplessness you would feel during such a moment, regardless of whether you're long or short. And the feeling of terror when you're short on good margin, a few dozen contracts. You just watch your account go to hell in secconds, eat your life savings in minutes, another 100K or so every minute, and you just pray for it to stop, and it has only begun...

I think it's an issue well worth thinking about. We all need protection. Just "playing less margin" isn't enough. Whether you trade ES with $500 per contract or $10,000 per contract, you will die or at least very terribly suffer either way.

So, protective options positions etc are well worth thinking about, as well as of course a wise asset diversification plan; IMO It's always good to have reserves of money (cash), gold, platinum, diamonds, real estate, and some speculative ventures like art & collectibles. I have invested into all of these (except RE because I'm waiting for the bubble to burst over here), and it does make you feel a little safer, particularly if you think about potential of inflation, war outbreak etc...

Anyway, will sure be an interesting thread this...! :)
 
I'm a free market kind of guy, and if you go long futures and expect somebody to bail you out when you lose it all in a market crash, then you are an idiot.

When it comes to trading there is no emotion, no morals, just numbers.
 
Quote from saschabr:

This is done to prevent blowing away the entire margining system in order to protect financial system stability during extraordinary events.
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What I think Saschabr is trying to say is that if the folks who run the markets let everything fall as specified (meaning the shorts are owed the money), then the whole thing would collapse like a house of cards.

Take me for example. Suppose I was long 30 contracts with 60k in my account. IB finds me a buyer and gets me out -500 and I now owe IB 690k. I ain't got that, man. You can't get blood from a stone no matter how hard you squeeze, and you are not getting 690k from me even if you sell my body to science, LOL.

And I'm sure there would be a host of other accounts in exactly the same situation, uncollectible debt in significant fractions of a million dollars each (or more). It would make the S&L bailout look like penny-ante poker. Economic ruin (not just for the unfortunate longs, but for everybody) lies down the path of not changing anything. So Saschabr's argument that one does not need to self-insure has a valid point, and we can continue to discuss that if y'all wish.

However, it would also be interesting to see some discussion about how one would go about insuring against misfortune of this nature. I know a fair amount about plain ol options (and somebody somewhere is really unhappy that I know what I know :D ), but I don't know anything about futures options. Do they have LEAPS? What would be a good strategy to insure oneself against multi-hundred point sudden moves?
 
Thanks for bringing some sense to this.

Those that are leveraged cannot expect to enjoy the added gains that margin provides and expect that the powers-that-be will bail them out just because the unexpected happens.

I'm sure most of us have signed disclosures that by using margin one can lose more than the total equity in one's account. That's the risk of using margin.


Quote from Reitberg:

I'm a free market kind of guy, and if you go long futures and expect somebody to bail you out when you lose it all in a market crash, then you are an idiot.

When it comes to trading there is no emotion, no morals, just numbers.
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Quote from saschabr:

The exchanges have to protect integrity of the financial systems.

Such a thing never happened, so it is difficult to speculate about real-situation solutions.

I am a licensed and during some theoretical seminars we were taught of such possibilities, however, not in depth.

A possibility would be that an arbitrary position entry price would be set. E.G.
a buyer & seller matched originally @ 1120. Both get the entry price adjusted to 720.

This is done to prevent blowing away the entire margining system in order to protect financial system stability during extraordinary events.
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It might preserve the margining system, but it would blow away the trading system and the integrity of the exchange. No one would ever trade there again, and the exchange and its directors would be facing a mountain of lawsuits from extremely well capitalised financial institutions. It would basically be an immediate death sentence for the exchange in question, so it is very unlikely to happen IMO.

Also you are wrong in saying that a huge gap move has never happened. October 87 saw several futures exchanges having gap moves overnight of 30-50% (e.g. Hang Seng, Nikkei 225), and not only did the shorts get paid out, but AFAIK no general clearing members went broke. The solvency of the exchange clearing house was not threatened.

You have to remember that the majority of futures traders are hedging institutions in "the trade". They are not leveraged on their positions, so although a 50% overnight gap would be painful, they would still have the resources to pay it out.

A much more likely scenario is that, if the gap were so big that the major longs went bust, owing more than the combined capital of the general clearing firms and the exchange clearing house, thus leading to the clearers and the exchange going broke too, the central bank/government would step in and coordinate a buyout of the now insolvent exchange. The purchase price would then be added to the deficit, meaning that the shorts would get paid the vast majority of their winnings. It is also quite likely that the central bank or government would make up the deficit and/or intervene in the markets in order to stabilise the situation.
 
Quote from Reitberg:

I'm a free market kind of guy, and if you go long futures and expect somebody to bail you out when you lose it all in a market crash, then you are an idiot.

When it comes to trading there is no emotion, no morals, just numbers.
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This is a totalitarian and arrogant statement, and I disagree! How dare you call anybody who differs on your point of view an "idiot"? :confused: :eek:

Here is my point of view:

I don't believe in luck as a justification for anything. I extract a very good living from the market every day, and that's because of hard work, and because it doesn't involve any luck.

"Luck" as in coincidence, is just an excuse for lazy and hopeless people, so they have another excuse in their life to not do anything. If people want real luck, as in, a reward to their deeds, then they have to put their a$$ on the chair and work.

Let's face it: Most instances where somebody is very "lucky" involve someone else being very unhappy or at least having to pay for it in some way. Luck is like a sudden shift of favor that brings out of whack the laws of pure Darwinism, giving a moment of strength to the weak ones! That's not the markets! The markets are ruled by the strong ones, to consistently divide the wheat from the shaff. Does this sound fair? No, it doesn't sound fair, but it's as fair as you can get. You get what you work for.

This said, let's get to the point being: If the market drops 500 points, and you're short, well, that's good luck. Well, is it? It's certainly very, very bad luck for those who have to deliver, and they had no chance, and no choice. I think anybody who makes money on other's misery to such an extent as instances on 9/11 - as an effect of terror and without any warning - Doesn't even deserve to be looked at. Not only a shame to those who lost all that money on the other side of the trade (and their houses, cars, families, superannuation savings, life), but also those who had to suffer directly from a terrible incident like that. Making profits from disasters like that shouldn't even be legal.

The fact that I personally insure myself in all kinds of protective measures still doesn't mean that I agree with the system. I only do this because I have to.

The way I look at it, I think there should be a "lock threshold" of extreme market excursion, beyond which neither buyers nor sellers should be able to trade anymore, and everyone to exit at their current profit/loss level. This way, those that were "wrong" are protected against worst case disasters, and those that were "right" can still exit with a very decent profit indeed. What's wrong with that?

Anybody making money on an extreme spike or crash, then calling himself a "good trader", should be highly ashamed of himself. It has nothing to do with being "right" or being "a good money manager" or anything, it only has to do with being lucky in that very moment, and taking other's lives away. I laugh at those who made money on such a "deal" and claim it's all fair. I wonder what those clowns think at the next crash, when they're the other way this time, and the market moves 1,000 points against them? Ironic and astounding how people always change their minds according to the way the wind blows.

Not to mention the potential advantage for terrorists to make huge profits on such gigantic moves, knowing well in advance what's going to happen. Nobody tell me there's no way terrorists get away with playing disasters. Of course they do. There are so many futures and options markets in the world highly correlated or totally reliant on the US markets, which the US has no power over whatsoever. It has happened, and it will happen again.

Oh, and of course last but not least the settlement issue which TGregg very rightly pointed out. How many could actually deliver? I guess most of those trading on margin couldn't. No blood from stones, so there's no money there, ergo no delivery, ergo no "lucky money" for the bears, anyway. There would be so many defaults (thousands?) that the whole process would be more trouble than worth it. And the fact that they have signed a risk disclosure doesn't mean a lot of people won't just grab whatever they have, hock it, take their gold & diamonds, draw the cash out of their swiss accounts and leave to another country. I sure know I would. That's why I have those "protections". If I was to lose, what, easily several millions in one go? F*ck justice and silly disclosures I say. What have I got to lose anyway? I'm sure many would agree, and render the whole delivery "requirement" but a useless gag of the NFA or whoever made it up.

So, we have as pro-arguments for my idea of "thresholds" against:

- Potential of intended profit from Terrorism
- Exploitation of misery and terrorism by those who were "lucky"
- Exploitation of others not "responsible" for their trade extreme
- Impossibility of full delivery of all contracts / default disaster
- Complete contradiction with darwinistic laws
- Gratification of "lucky" people, rather than hard-working people

And probably a lot more others. Just to pour some oil into the fire.

Any good anti-arguments? :)
 
Quote from TGregg:

Suppose I was long 30 contracts with 60k in my account. IB finds me a buyer and gets me out -500 and I now owe IB 690k. I ain't got that, man. You can't get blood from a stone no matter how hard you squeeze, and you are not getting 690k from me even if you sell my body to science, LOL.

And I'm sure there would be a host of other accounts in exactly the same situation, uncollectible debt in significant fractions of a million dollars each (or more). It would make the S&L bailout look like penny-ante poker.
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In that case, your broker would be liable for your 690k. If your broker went bust, then their general clearing firm would be liable. If they went broke, the exchange would be liable. If the exchange went broke, a buyer would be found and the purchase price used to offset the liabilities. If that still didn't cover all the liabilities, then the shorts would be left with a claim as creditors against the exchange. In the event that the government did not bail out the exchange, the shorts would be out of pocket to that amount. But that's the risk they knowingly take by using a futures contract rather than selling the underlying. Credit risk is a part of doing business on a leveraged basis. They can always privately negotiate a forward contract on an unmargined cash basis if they want to eliminate that risk.

The S&L bailout cost well over a hundred billion dollars - I doubt that an exchange default would approach even a small fraction of that amount. It most likely wouldn't come close to endangering the US financial system, and if it did, well, that's what central banks are for.
 
Quote from Cutten:

In that case, your broker would be liable for your 690k. If your broker went bust, then their general clearing firm would be liable. If they went broke, the exchange would be liable. If the exchange went broke, a buyer would be found and the purchase price used to offset the liabilities. If that still didn't cover all the liabilities, then the shorts would be left with a claim as creditors against the exchange. In the event that the government did not bail out the exchange, the shorts would be out of pocket to that amount. But that's the risk they knowingly take by using a futures contract rather than selling the underlying. Credit risk is a part of doing business on a leveraged basis. They can always privately negotiate a forward contract on an unmargined cash basis if they want to eliminate that risk.

The S&L bailout cost well over a hundred billion dollars - I doubt that an exchange default would approach even a small fraction of that amount. It most likely wouldn't come close to endangering the US financial system, and if it did, well, that's what central banks are for.
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Great post, Cutten. But are you serious about your broker being liable for your loss? Brokers go out of their way to roll all liabilities off to you. How could your broker be liable for your own trading loss?

This just doesn't seem to make sense to me.
 
saschabr, yes, it has happened before when on the London Metal Exchange yonks ago they had a crisis over their tin futures contract. Shorts were partially robbed to save the longs .. its called a ring-out.
 
Quote from Cheese:

saschabr, yes, it has happened before when on the London Metal Exchange yonks ago they had a crisis over their tin futures contract. Shorts were partially robbed to save the longs .. its called a ring-out.
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Sounds fair enough though, doesn't it? :confused:
 
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