Why do I keep breaking my risk limits in Volcube?

It is very common for Volcube newbies to break their risk limits. This registers a bad TPI score, so it is always best avoided. The good news is that there are usually only a couple of reasons why this is happening and it is an easy thing to rectify. Furthermore, it is a very important trading skill to acquire, so if you find yourself breaking your limits regularly, read through the following and check which apply to your games (hint: it may be several).

1. Trading too big

In a typical Volcube Levels game, you can usually hold roughly 700 at-the-money options (long or short) or an equivalent amount (say 1400 wing options with half the vega of an at-the-money). So if you buy 500 at-the-money options in your first trade and then 300 in your second, that is likely to send you over your limit. The solution is simple; trade smaller. Do not trade 500 at-the-money options in the first iteration. It makes no sense to use up a lot of your risk capacity when you have so little information to trade on. You should only trade big when you are feel confident the price is amazing (i.e. there is plenty of reward) and/or the trade seriously improves your position (it reduces risk).

2. Not adjusting your option prices quickly enough

 Remember that the option price directly reflects the price of implied volatility. If implied volatility has risen in the market, but you are still pricing options as if it is unchanged, then you are under-pricing. It is very likely that the broker will lift your offer (i.e. buy from you) and you will start to become short options. It is very common for Volcube newbies to not realise that implied volatility is moving and to continue pricing options straight from the theoretical value. This is a recipe for accruing an unbalanced position at increasingly worse levels. For instance, a player is asked for a price in the at-the-money puts which are worth 3.15. She makes 3.10 bid, at 3.20 and gets lifted (i.e. sells) at 3.20. The broker then requests a price in the at-the-money calls, also theoretically worth 3.15. She makes 3.10/3.20 and sells again at 3.20. Then the puts are quoted again and she yet again shows 3.10/3.20, selling yet more at 3.20. This makes little sense and is a sure-fire way to blow risk limits quickly in a game. After selling at 3.20 the first time, it only really made sense to sell more at 3.20 if she felt they were a great trade and she regretted not selling more when she had the chance. But by the third quote, this explanation doesn’t really hold water. Far more likely is that she is simply not adjusting her prices at all. Instead, something like 3.15 bid, at 3.25 may have been a better second quote. If she was lifted at 3.25, her position may be the same as in the first scenario but at least she has sold, on average, at a better price. In this second scenario, she might show say 3.18 bid, at 3.28 for the third quote and possibly start to reduce the quantity attached to the offer price. By doing this, she is showing that realises implied volatility/option prices are rising in the market and she is increasing the reward she requires for adding to her risk.

3. Knowing when you are cornered

If you have traded too big or not made accurate prices and therefore accrued a lop-sided (i.e. big) position, then you need to recognise this. Volcube newbies are often only one small trade away from disaster but they are blissfully unaware of the fact! Monitor your risk limits in the Risk Limit pane carefully. An amber light should cause you to take immediate action; it means your quotes must take special notice of your position’s character. If you are very long options, be on the look out for opportunities to sell and be very careful about what you buy. And when you are right up against your limits, make sure that you will not trade in any way that will push you over the limit. Show a dreadful (i.e very high) offer price if you are very short. Ensure in such cases that if you are lifted, you can immediately buy back (effectively arbitrage) the trade without your risk situation worsening. When you are limit long or short, that’s it; you are completely handcuffed and your only concern is to reduce the risk IMMEDIATELY! Forget about the competitiveness of your quote (i.e. the width of your spread) in such cases. Staying in the game is far more important.

The bottom line…

If you are regularly breaking your risk limits…

  • Trade smaller, especially in the early part of the game. Stick to 100 lots for at-the-money options until you have a good sense of what is happening in the market. Trade bigger only when you have good reason.
  • Learn to adjust your pricing. THIS IS ALL ABOUT ACCURACY! Pay careful attention to the Pricing Accuracy Metric in the Analysis screen after every game. Check out this article about how to price accurately.
  • Be aware when your risk is large. And if the worst happens and you are at risk of breaching your limits, make dramatic adjustments to your prices to prevent your risk limits being broken.

Have a question for the author? Happy to help! Email [email protected].

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