I wanted to know how Zerodha’s RMS would have handled the unusual movement of the Sensex 83,000 PE that happened on 14th Nov , when the premium went from 1 to 45 in a matter of minutes without any movement of the index.
Even if someone would have hedged the position using a Long Pe, it wouldn’t have protected him as the long pe premium wouldn’t have spiked to cover the loss of the short pe (the unusual movement only happened for the 83000 PE)
E.g: If I enter a position like below:
-Short PE with premium of 50
-Long PE with premium of 5 (For a Weekly Nifty Expiry, this might be 500 pts below the short PE’s strike Price)
For the above position, theoretically the loss at expiry should not be more than 455pts) .
Now what if due to some reason (like what happened on 14th Nov), the short PE’s premium goes to 2050, with the long PE still remaining at 5.
Will the RMS square which will probably result in more than 50% loss of capital?
It would really help if someone knowledgeable can clarify this
For the RMS team these scenarios aren’t new; unusual spikes on individual strikes happen from time to time for various reasons. It’s relatively rare in efficient markets, but it does occur.
In most cases, the margin blocked for short positions should cover the max loss. When these spikes happen, we don’t rush into action because algos typically capture and correct the mispricing pretty quickly, usually within seconds to minutes.
Our approach is if the underlying isn’t moving much, we wait and assess the risk exposure. Let the price normalise on its own. However, if the abnormal pricing persists and the underlying starts showing volatility, we have to liquidate the position when you start losing more than 50% of capital. Here we will not consider profits on the long leg.
The key is distinguishing between temporary noise and real risk and acting decisively when it’s the latter.