Catastrophizing

Should we be so worried about the “worst case” scenario?

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” — Peter Lynch

I had my good friend Brian Lund (@bclund) on my podcast as a guest to chat about whatever came to his mind in the options world. Whenever I have friends on, you can expect the conversation to be fast and loose. And going in, I actually had no idea what we were going to talk about. This was going to be improvisation at it’s finest.

But much to my satisfaction, we quickly got into two very important topics: Systemic Risk and how it leads people to make poor decisions based on false extrapolations of how bad things really were.

Brian kicks off with a fantastic story (depending on your perspective) of what happened to one of his options positions into the teeth of the 2008-09 financial crisis, a time when the stock exchanges changed the rules in the middle of the game and market makers stepped away from their responsibilities to maintain orderly markets. Caught in the crossfire was Brian, sitting in what should have been a monster profit, but with no means to exit at a fair price. Recounting the story, Brian and I discuss steps we can take in the future if ever faced with a similar situation.

Our conversation then naturally melted into a broader discussion of protecting ourselves against fatal knockout blows to our trading accounts. While it may be important to do so, are we applying too much weight to our memories of past market crises? Were things really as bad as the legend has turned them into? Would our portfolios really have taken such a drastic hit? Would we really have been knocked out of the game?

Maybe we’re making a much bigger deal out of traumatic experiences than is rational.

I make the argument that perhaps instead of throwing money away on ineffective hedges, perhaps the best defense is to stay offensively consistent in our strategies, fully accept that our equity curves will never go straight up with no interruptions, come to terms with the fact that we’ll experience occasional bouts of P/L volatility, and that keeping necessary fire power in reserves for the rare (but expected!) times when volatility explodes may turn out to be the most profitable move you ever make!

Spend some time, share some laughs, and hear us out. And after listening, if you’d like to chime in, please do so in the comments section below, or ping me on twitter or StockTwits @chicagosean or email gimmesomeoptions@gmail.com

The Gimme Some Options podcast recently launched! It’s a mostly daily broadcast which dives into the options trades I made each day and why, as well as occasional interviews with other options traders. I seek to learn from everyone and share stories that will educate, enlighten, entertain, or scare you right out of your pants.

Archives are available on Soundcloud and you can subscribe on iTunes.