Once we’ve selected a disciplined entry point and begun riding the bear, the only threats to our profitability are human error or a new spike low in the market. Given our preconditions, there is only one generic occurrence that might generate enough selling to produce such a spike. Such occurrences are historically extremely unlikely, and probably would consist of some legitimate scientific research emerging (as opposed to some ridiculous headline in the tabloid press) that indicates that demand for this market’s product may or will be sharply lower in the future.
In a foodstuffs market,this might be represented by an article in a respected publication, the Journal of the American Medical Association perhaps, that indicates the existence of a severe health hazard to consumers of our market’s product.Now, Homo sapiens have been eating the products of all the tradable edible agricultural markets for millennia, and while this possibility exists, especially given the unfortunate prosperity and ubiquity of the less than honest health-scare industry, it’s exceptionally remote.
Another such possibility would be the discovery of a useful alternate fuel for automobiles and—necessary condition—the announcement of plans to create the distribution infrastructure required to make this new fuel available to the mass market.In either of these cases, whether the research ultimately pans out or not,just the announcement of it would likely send our market crashing lower, and we’d be in hell’s own trouble. However, this outcome as described seems to me to be quite impossible.
Why? Are we to believe that a legitimate piece of complex research such as just postulated will have no effect at all on the price of our market prior to its public announcement? Fiddle-dee-dee. Objective and independently duplicable research is practically impossible to hide in large, widely traded markets, particularly in regard to its putative future result. Some number of people will have or gain access to it and some of these folks will talk about it for any of a wide variety of reasons. (OK, OK, all you conspiracy theorists out there, I’ll exclude all the folks in the subbasement levels of Area 51.) Think it through.
The market in which we might otherwise have been riding the bear, we won’t actually be trading in—or, at least, not riding the bear in—because a rumor-driven market does not ever meet our entry qualifications, particularly the non-spike condition.Let’s Just Not Beat Ourselves:The second danger, much more likely, is that we will err seriously in deciding when to begin riding the bear. In the ideal case, we’ll have been observing an extended bear market, one that’s making or sneaking down toward multi-decade low prices, and we’ll have an obvious trigger event in hand.
These conditions aren’t at all impossible to meet simultaneously; the cocoa market in 1999–2000 was a textbook case. They just don’t all occur together frequently.If, immediately or very soon after we enter the trade, we find out that we’ve goofed in selecting the entry point, we’ll run for the exit. The indicator of our error will be a new spike low, perhaps a 4–5% or larger drop in a single day, and there’s unfortunately no good way to combat or defend against this. If, however, the put options only have a week or less to live, we might have a defense.
We’ll have to review the supply/demand situation in our market again, to make as certain as possible that we haven’t overlooked an important development in the market. We’ll definitely want to consult our various informed sources (you are compiling a list of your sources and potential sources now, I hope), and learn whether today’s sizeable drop was a one-off event and unlikely to recur . . . or something more serious.
Please permit a small digression here. A two-pronged approach is best in trying to evaluate the new market situation after a sharp dip. If possible,call a cash market broker for the supply/demand part of the question. These guys’ living literally depends on their keeping abreast of the latest supply/demand developments in their market, and they’re our first, best resource without question.
This is completely reasonable if you consider the matter. Nestlé, Hershey’s, Cadbury’s, E. D. & F. Man and their cash market colleagues should know functionally everything going on in the cocoa market, shouldn’t they? Suppose that your cash market source says that there haven’t been any developments, now what?
Now we turn our attention to the exchange, in cocoa’s case either NYBOT or LIFFE, and pick the brains of our broker’s floor people and any other floor sources we’ve been able to acquire. It’s likely enough that we won’t be able to talk to our floor sources while the market’s open; they’re probably having quite a wild day themselves. Trying to pull them off the floor to answer a question is not only rude, it’s a waste of your time and theirs.