Try as I might I’ve yet to fully extinguish fear from my decision making process. Like an obsessive ex-girlfriend it seems to continually pop up at the most inopportune times. The potency of fear is inextricably linked to both the size of a position as well as the magnitude of any unrealized loss. Just as the SPX was on the verge of falling into the abyss following the Fed’s uninspiring remarks, good ole’ Mr. Fear paid me a visit. While the prudent action would have been to up the ante on my short volatility exposure, I simply couldn’t do it. The existing loss was already too big and the fear of throwing yet more money down the toilet too paralyzing. Because my emotional capital had already taken a hit, I didn’t have enough in reserve to support making the most profitable decision. Furthermore, my ability to manage the position properly going forward has been somewhat compromised.
How so?
In an ideal world we would all wake up each morning with a clean slate void of any emotional baggage. In the real world we have this remarkable thing called memory which is both a blessing and a curse. Yesterday’s failures linger. Like an insidious doctor they inject unwanted doses of subjectivity into our psyche. Such is the residual affect of drawdowns in emotional capital. So, although the most profitable route maybe to maintain my short vol position for an extended period of time, odds are I won’t. Not on this trade at least. A return to breakeven is quite sufficient for one as emotionally drained as me.
I’ll get ‘em on the next one. I highly doubt today was the only opportunity we’ll have to short volatility at elevated levels.
For related posts, readers can check out:
Sometimes I’m Infected by the Stupidity Virus
I’ve Seen This Movie Before
A True Meritocracy
{ 7 comments… read them below or add one }
Hi Tyler, great articles as usual. I think that long XIV is a much a better vehicle for shorting vol, as opposed to short VXX. Have you considered that? There is good list of reasons why long XIV is superior here http://understandingvolatility.com/2011/07/24/trading-strategy-long-vxx-xiv/
Hope it helps!
Mondo
Hey Mondo,
Sorry for the delayed reply. To be honest I hadn’t yet done much research with all the other available VIX ETPs. I agree that shorting VXX has more risk than buying XIV, though the proper use of stop losses should mitigate the excessive theoretical risk accompanying short positions.
I have (or all of us have?) the same problems. I solved it by simply mechanizing trading – creating rules for money management, entering, adjusting and exiting. Sure there are times when discretional methods apply. With the faith that the strategy is profitable in the long-term i`m ok with taking loses in 1-2-3-4 consequent months. Not feeling happy of course, but how does 1 or 2 losses matter (if it`s not over the limit)?
BTW backtesting helps to keep the faith alive
Good points Dmitry. Automation is indeed an effective way to remove the emotional aspect. My current position is partly a result of becoming a bit too casual in my approach. Lesson learned.
Tyler,
A fantastic topic for discussion. I want to kindly suggest that you are making a couple of mistakes that are avoidable. These may be debatable ideas, but please consider them.
1) With a trade plan in place, you would never have reached that fear point. The losses would never have reach that level. You would have been out, or reduced risk earlier. I understand that an experienced trader doesn’t feel a trade plan is needed and that he/she can do the right thing under duress. You just proved that you cannot.
If you think that I have never been there and don’t really understand, let me assure you that I get it. In Oct 1987 I was trading an account that was NAKED short more than 1,000 OEX puts. I know fear. And losses.
2) If you wanted to remain short that vega, there were new positions you could have established that were far less risky than the one that was causing such pain.
3) Thinking about ‘break-even’ is a bad idea. The trade is worth owning, or it isn’t. Whether it is a profit or a loss makes no difference at the moment that you want to get the hell out of a trade.
Hey Mark,
Thanks for your thoughts. I agree with all points (as usual). Matter of fact I’m sure I’ve written about most of your suggestions in the past. I suppose my predicament reveals the fact that their is occasionally a disconnect between what I say and what I do. Shame on me:)
@MarkWolginger
Dear Mark,
You mentioned that \ If you wanted to remain short that vega, there were new positions you could have established that were far less risky than the one that was causing such pain.\
Currently I feel the same pain shorting the VXX Jan calls. Would you please share the other, less risky way to short vega? By the way, what do you think is the safest (or least risky) way to short theta?
Thank you!
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