Dazed and Confused

So on that morning I came down to the exchange at about 5:00AM. I wanted to find out what the EFP market (Exchange for Physical) was doing. I had been up the entire night before, watching anything I could on TV and listening to regular updates on the radio.

I wanted to see if I had any out-trades. Fortunately all I had was a “bracket-out” with a broker. The futures were called 100 higher, two strikes. A lot of people were expecting the demise of the entire banking system at that point. And, to make matters worse, my clearing house was owned by Continental bank. Rumour had it that Continental took a BIG trading hit as a result of the clearing house that I used. And it was supposedly two individuals over at the CBOE who were short premium that were possibly taking the firm under.

I walked onto the trading floor. Pandemonium seemed to be the mood. The S&P pit was not open, trading had been suspended. And the futures were still called 100 higher. Of course, anybody who had an out-trade the wrong way was “dead”. People walked around on the trading floor, folding back the lapels of the trading jackets. Nobody wanted to be caught with a $100,000 error because somebody wrote down their badge acronym by mistake. Bonds were called lock-limit higher.

I don't remember if it was just before or just after the market open, when Paul Volcker made his promise to flood the market with liquidity. Because of the risk of even stepping into the pit, I didn't go in. I had a long gamma position similar to the one we've been following.

As the market opened, the futures moved 300-325 points higher. This was the largest move ever in the history of this market. Basically I wanted to get as delta nuetral as possible. I taked to my friend B., who has long since retired from trading and moved to his boat in San Diego. B. was a size trader and I respected his opinion as a friend and trader.

So I caught my breath and counted the number of futures I had on an implied way. I was not even seeing straight at that time, my heart was beating so fast. So let's take the position we've been working with (which was NOT my position) and see what was implied. Volatility was now in the 30-40 % range. Let's count 'em up.

EDZ87 +264

Strike***Puts***Calls
92.50****-----*** +45
92.00****----****-56
91.50****-25***+172
91.00****-05****+45
90.50****-25****+223
90.00***+102****-25
89.50****-54****+35
89.00****+75-----****

We were delta neutral as of the close of the previous session. So let's move the strikes by a factor of six and net out what we've got. The puts will be worthless. The calls are all in the money So added together, we are net long 349 calls that are in the money. And we are long 264 futures.. This is a total of being long 613 futures. (My actual potition did mirror this, to some extent, but I did not sell as many futures).

Shaking, I looked at the futures market. It was 93.00 at 93.25. So, the right thing to do was to sell 613 futures at the market. It took almost two hours to get the fill. The market remained there at those prices about an hour. I got the fill out of the pit, I had sold at 93.00. But finally, and gradually, the market dribbled back to 91.62. I bought in all the futures I had sold. Using the “fake” position we've been analysing, this would be for a profit of 84,594 ticks, or $2,114,850.00.

Now, back at 91.62 I calculated my rates of change. Remember that I was still hugely long straddles, although at 30% + implied volatility. The volatility in this had jumped some 13%. At higher volatilities, the position would be LESS long premium (straddles), not more. The next task was to get rid of the premium, So the plan of attack was to get rid of the straddles and strangles. Institutions were in shock, the locals quoted HUGE markets. But I needed to liquidate the position at this point. So, I aked my old friend Br. to execute some delta neutral trades for me, first the 91.50/92.00 call vertical. I did three more trades that day, as volatility started sucking in and the market hovered lower.

All in all, for me it was a good day. I bought Dom for the entire Merc Club bar. I didn't know at that time that my clearing house might be going belly up, making any profit I'd earned possibly moot!

Happy days are here again! Or maybe not!