Wow 50 to 100 points...The last time we fell that much in % terms is the first trading day after 9/11.
The short answer I can give you is that there is nothing I can do as far as protecting myself from such an event except to not put 100% of my portfolio in such a position. That alone ensures that such an event will not wipe me out and still be around.
What I would do would depend so heavily on what is happening. Is this a full market crash, a crippling terrorist attack a major fundamental collapse, etc...?
Time to expiration certainly matters because plenty of time to expiration means the spread is not at a maximum loss value and if the market looks like the bottom is falling out I would be inclined to close it out quickly, sell as many call spreads as I could on the other side to bring in premium and add long puts/long put spreads on the SPY or SPX to generate some loss reducing profit. This last part is tricky becauase I do not want to put more money at risk and have the market reverse back on me, increasing my losses now with the shrinking long puts/spreads. This would really be fact specific.
The other part of this is the realization that if the market is collapsing as it is, then I need to close out my exposure as best as possible and focus on making money each and every remaining month in the year to reduce my losses. If this happens in January, I have the whole year to crawl back sicne I have not been wiped out. If it is December, I have almost a year of profits to cushion the blow to result in a smaller loss and I take a losing year with smaller losses than the market which has collapsed. if it is in the middle of the year or so, it is a balance of the two. The true protection against this is how much capital you put into the strategy to begin with. if you put in 50% of your account, you will not even lose the full 50% unless you wait until it hits maximum loss on the bad spreads. But the losses could be significant initially and if it happened to me, I would simply focus on the next month of following the same approach and make it back slowly month to month. Cannot exepct to wipe it out in one month.
So bottom line, the first defense is to not put 100% of your capital in this one strategy. Second, if the market is tanking then it depends on har far OTM you were. Rolling down might not do anything if you were within 20 points or so and the market is collapsing 30 or 40 points and looks like it would go for more. In those cases you need to close that spread fast and a follow up might be to add some bearish puts while rolling down or adding call spreads to bring in as much premium as possible. If you had margin room, I would add more call spreads then I did before for even more premium. When the market finally rested and bottomed, and it always does after collapses, then I might even choose some OTM put strikes to bring in as much credit as possible. The more safe credit I can bring in the more I can reduce the effects of the losses as best I can.
The other approach is I would begin shorting futures as the crash was coming and still roll out of my puts and use let the futures shorts run as much as I could. Any profit you can make would cushion the blow, and I would still roll down the calls and sell as many as possible and later on add puts. Taking a loss would no longer be an issue but how big a loss I would take I could control to an extent.
If you have the software you can stress test your portfolio and play around with different scenarios.
There is no easy answer since in this case the loss is inevitable. What my approach would be is to take measures to take in more premium (close puts and calls and re establish positions) and add profits (long puts/spreads or futures).
Phil
Quote from rdemyan:
Coach: I'd like to discuss a hypothetical event and hope that you will go through the general strategy you would use to deal with the event. Of course there would be decisions you would make based on specific option prices, but if I could just get a feel for how you might respond.
Event: Catastrophe that causes the S&P futures to drop by between 50 to 100 points or more. Assume that the S&P will gap down an equivalent amount. You have a bull put credit spread that was within 20 points of the S&P price just prior to the catastrophe. So now the short on the credit spread is 40 or more points in the money.
How would you deal this and how would time to expiration (i.e. 6 weeks or less) affect your decisions. Is it just a total loss and you try to make money using other methods in the market (ie. buy SPY puts or placing directional trades of some sort).
This is the one scenario that gives me the most cause for concern.
Thanks.
