Feb

1

Stops, from Zubin Al Genubi

February 1, 2022 |

Here is a thought experiment. There is a market with 1 buyer and 1 seller. The seller has 1 testing sell stop in place at 0. If the buyer can see it, he will take the free offer. If he cannot see it, he will explore with low bids moving at some point to 0 as a buyer wants the best price. Seller takes a loss.

Another day, 1 buyer, 1 seller, 1 offer at 100. Buyer has to buy and so searches, finally taking high offer.

The seller's low stop results in a loss. Can this be generalized?

Ani Sachdev writes:

I don't trade options - I think it's a fool's game to pay/sell premiums. If I have to trade I prefer futures (but I much prefer just buying and holding). I have, however, read a lot about options, and Mr. Taleb's book Dynamic Hedging is excellent at highlighting the important concepts. This conversation reminds me of his description of liquidity holes, on page 71:

Since stop losses guarantee an order, it becomes understandable that some operators can have an incentive to trigger the large stops. The following example shows the execution of a stop-loss in a relatively less liquid market.

[See the book for the chart that follows the above quote.]

Larry Williams responds:

I kind of see stops like getting in a fight… And somebody beating the hell out of you. The best strategy is to run.

That's why I always use stops there, they protect me from getting beat up… And they protect me when I'm not watching the market; which is most of the time.

Kora Reddy writes:

don't worry neither taleb trades options, just my personal opinion, take it with a pinch of salt:

1) taleb recycles others knowledge in a complicated and nonsensical way and presents it in a non readable gibberish manner vs

2) Euan Sinclair explains the same complicated options stuff in a straight no nonsense way and easy to understand

3) think like speaker Nancy Pelosi: go farther out like 2024 Jan leap, spy around 450 levels, I need about 45k to buy one contract if I go via vanguard route [i.e., 100 shares of SPY], but if I go deep itm calls at 400 strikes, its midpoint is at 80, one contract costs me about 8k with benefits about. 65 move for spy one usd underlying move and we know that spy average expectation is about 8 to 10 percent rise per year, so we are looking at 550 levels then, your 400 call is worth about 150 or roughly 90 bucks or 100 percent gains post tax vs no tax on 10k by 45k about 20 percent gains. the trick is to execute it when vix goes back to teens at much cheaper costs.

Editor's note:

Possibly of interest to readers:

Liquidity Black Holes
Stephen Morris, Cowles Foundation, Yale University
Hyun Song Shin, London School of Economics
September 8, 2003

Abstract
Traders with short horizons and privately known trading limits interact in a market for a risky asset. Risk-averse, long horizon traders supply a downward sloping residual demand curve that face the short-horizon traders. When the price falls close to the trading limits of the short horizon traders, selling of the risky asset by any trader increases the incentives for others to sell. Sales become mutually reinforcing among the short term traders, and payoffs analogous to a bank run are generated. A “liquidity black hole” is the analogue of the run outcome in a bank run model. Short horizon traders sell because others sell. Using global game techniques, this paper solves for the unique trigger point at which the liquidity black hole comes into existence. Empirical implications include the sharp V-shaped pattern in prices around the time of the liquidity black hole.


Comments

Name

Email

Website

Speak your mind

Archives

Resources & Links

Search