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Exactly my point (locking in immediate loss with synthetic vs trading out)
but said/explained much better. Bottom line is that there is no such thing
as a free lunch in markets e.g. a synthetic which will allow you to exit at
prices in effect before the news event. Protecting against a potential
re-evaluation is exactly what you buy for the cost of the synthetic and for
some, that may have the highest priority. The downside is that a) the
pricing of the synthetic is likely to price in the most extreme adverse
probabilities, b) one incurs commission and slippage costs for the long and
short option positions, and c) one is concerned with managing the options
trade in addition to the futures trade.
Before trading any contract, one should evaluate average, minimum and (most
importantly) maximum average true range over a multi-year period to gain an
understanding of the risk characteristics. With an understanding of the risk
characteristics (e.g. seasonal in grains) one can manage the risks
appropriately.
Earl
----- Original Message -----
From: cb <cpbow@xxxxxxxxxxxxx>
To: RAY RAFFURTY <rrraff@xxxxxxxx>
Cc: <realtraders@xxxxxxxxxxxx>; Howard Hopkins <hehohop@xxxxxxxxxxx>; Real
Traders <realtraders@xxxxxxxxxxxxx>
Sent: Saturday, August 14, 1999 5:18 PM
Subject: Re: Limit Down
> It's worth noting that a synthetic exit, implemented after a price
> shock, will *not* insulate you from the loss equal to where the mkt
> would have jumped in the absence of limits. If the mkt priced Dec corn
> at 200 after the report the mkt. would be limit down several days. The
> options (assuming they are trading and not at a limit themselves) *would
> price in 200 immmediately*.
>
> The scenario that a synthetic exit might help in is if the mkt.
> re-evaluates and decides Dec. ought to be at 180, and this increased
> bearish sentiment occurred while the mkt was still "catching up" by
> limit down moves. In this case the synthetic would have allowed you an
> exit at 200 whereas you wouldn't have that opportunity to exit in the
> futures.
>
> Note that on some markets the options stop trading if the underlying is
> locked limit.
>
> It seems that the only protection is being in an option position prior
> to the price shock, with the accompanying expenses, or simply trading
> small enough that a price shock won't wipe you out.
>
> I'm no options expert but I believe the above is correct.
>
> Conrad Bowers
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