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One Traders Story of the Flash Crash

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I received an interesting email this week from Hari Swaminathan from Option Tiger concerning the Flash Crash of 2010. The Flash Crash is something I talk a lot about here on the blog and I am always looking at ways to protect against something like this happening again. Hari had an interesting experience during the Crash in that he was Long Vega and saw his profits skyrocket during that day, but was unable to exit his positions and saw most of his profits whittled away by day’s end. Here is a recount of his experience:

Definitely an interesting experience Hari had, and hopefully one you can learn from in case this ever happens again. Sometimes in moments of extreme market dislocation, you need to adjust you trading methods slightly. In this case if Hari had simply sold his puts rather than trying to execute a spread order, he would have been left with some handsome profits.

“On May 6, 2010 we witnessed an event of bizarre proportions. I was on my computer and my trading platform on that day, at that time. At 2:40 pm in the afternoon, the Dow suddenly crashed 1000 points and then recovered 700 of those back in 20 minutes. By 3 pm, it was all over, but the world of trading had changed forever.

And luckily enough, I was nursing a Straddle trade on the SPX that day. You’re probably thinking I’m making this up – I’m not I promise you. Can you believe that? The Straddle is the ultimate Flash-Crash-proof trade. Your Long Puts are zooming in profit stratosphere, and your Long Calls have limited losses. The Puts can make up for the Calls 5 or 10 times over. A Straddle makes money regardless of the direction. It only needs a large move in either direction. The larger the move, the more money it makes. And if the direction is down, then all the better because Volatility is increasing, and the Straddle is a Double Vega positive trade. The VIX had skyrocketed to over 40 in a matter of minutes. You couldn’t ask for anything more really. Super duper right?

Nope – I could not exit my trade that day. It was terribly frustrating to see many many thousands of dollars of profit on my screen but I could not exit. When all was said and done after 20 minutes of FLASH CRASH, my trade had returned to a very small profit, no biggie..What a bummer ! I later realized that my mistake was I had tried to exit the Straddle as a whole – both Puts and Calls together as a spread. I kept changing the price of the spread  because the market makers wouldn’t give me a fill. I later realized that I should have just sold my profitable Puts, and let the Calls die out. Executing a single Option trade in that environment would have been the best thing to do to increase my chances of a fill – but things were happening too fast and furious, and adrenaline levels were so high, they obviously drowned out my grey cells. And it would have been a killer trade if I was able to close those Puts, because the Calls ultimately regained most of their value when the markets came back. I’ll kick my backside all my life on this one 🙂

But those 20 minutes wiped out many investors and money managers who had placed stop loss orders on behalf of their clients. I have a very interesting blog post on this topic, and also make sure to read the articles it references. From that day, every investor has to have another criteria for their trades – How will your trade do if there was a Flash Crash right now? The chances of it happening are obviously very small, and I’ll cover the topic of probability and expectancy in another post – but you have to assess whether a Flash Crash will be disastrous for your trade. It if does, then you must re-design your trade.”

Let’s hope the Flash Crash never happens again, but we have to face reality that it very well could. It could even be worse next time! Let’s read Hari’s last sentence again, just to make sure it sinks in:

You have to assess whether a Flash Crash will be disastrous for your trade. It if does, then you must re-design your trade.

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8 Comments
  1. Noel says:

    I have always been thinking about this. And expecting it too. So I try to trade bear calls instead of bull puts. This is not perfect but it should prevent me taking a big loss in case it crashes down.

    1. Hi Neol, thanks for your comment. That’s certainly one way to go, although you might have taken a few hits recently with this steady uptrend?

      Here are a couple of posts you might be interested in that talk about protecting the downside:

      https://optionstradingiq.com/calendar-spreads-for-downside-protection/

      https://optionstradingiq.com/how-to-protect-iron-condors-from-a-flash-crash/

      Hope these help, let me know what you think.

      1. Noel Soliva says:

        Great article. I have used the OTM Puts to protect me before and it worked.

    2. Hari Swaminathan says:

      Bear calls are definitely better because you get the Vega advantage. i.e. You’re losing on Delta when the market is going up (against the bear call), but volatility is dropping, so negative vega is offsetting somewhat. Also, if its a bear call, you generally have time to think and plan out your adjustment. Check out this trade I had last week on a bear call on GOOG. It went against me bigtime, but because its a bear call, and GOOG creeped up on me, I had time to adjust it.. http://www.optiontiger.com/goog-bear-call/

  2. Rob says:

    I love this story. Because a week or so ago I opened an April IC on the RUT, and later that day opened a protective Far out of the money protective April long strangle, but paid too much for it, so I will lose a net 5% on a 17% credit IC. In this scenario, when the RVX was spiking to +20%, I would be ready to dump trade and break even or make money because my net position was slightly long vega. I was expecting a potential “Flash Crash” on March 1st with Sequestor. So far things are calm, but the way I am positioned, I may not even been able to dump anything after all, unless I make market makers happy selling individual options, or let strangle go worthless. Well, I guess that’s the price for insurance, rarely getting the benefit from it.

    1. I hear you Rob. I like to have some form of insurance as well, but it does come at a cost. It would be interesting to analyse how often these market meltdowns occur and weigh it up against the cost of insurance. I remember reading somewhere that the cost of insurance is basically not worth it in the long run, but I still like to have it just in case. It also helps smooth out your returns a little bit also.

  3. Hari Swaminathan says:

    Gavin, I was excited to see this post here on your blog. It was one hell of a trade indeed (even if it never played out). I’ll never forget this one..Thanks for posting it here..we should talk sometime.. Hari Swaminathan

    1. Sounds good Hari. Shoot me an email and we can arrange a time to catch up.

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