Pregnant Elephants

Those who follow Dan Sheridan will hear him constantly refer to the pregnant elephant. My understanding of a pregnant elephant is the idea that the price of the underlying will retrace after a swift unidirectional move up or down.

When I first found this forum, I hear forum members talking about price retracements as a norm, as behaviour to be expected. In other words, the pregnant elephant is not a myth, but is out there in the market, wreaking havoc to income traders who do not understand it.

I did not believe in the pregnant elephant when I started dabbing in income trades. I was busy getting myself delta neutral before giving the elephant a chance to back off. More often than not, I locked in a loss as a consequence. Over time, through experience and observation, I'm starting to be converted. I changed from a skeptic, to a believer of pregnant elephants.

Do you believe in pregnant elephants? Or is it just hogwash?

I've heard Dan use the term pregnant elephants and can't say Im a believer or not as I figured it was his own way of describing how he manages his trades regarding market movement in relation to premium selling. It does however makes sense to me when he mentions about the behaviour of a pregnant elephant and how the market retraces.

I really like his 'bad neighbourhood' metaphor, have incorporated it into my own trading. Noone likes a bad neigbourhood, except maybe MMs

oh.

i was expecting to see some fat chicks here...

never mind.

carry on.

Grinder said:

It does however makes sense to me when he mentions about the behaviour of a pregnant elephant and how the market retraces.

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I personally think that it is prudent to start imagining a huffing and puffing pregnant elephant when the spot has moved 1 standard deviation. After moves of two standard deviations or more, chances are the the elephant is puffed out.

Grinder said:

No one likes a bad neigbourhood, except maybe MMs

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I like this one (ie. metaphor)! When I started out, I did not even realise that I was in the bad neighbourhood, until it was too late. I was walking alone in the hood at 2 am, loaded with bling and my rolex, got mugged, stabbed and bled to death.

sam76 said:

i was expecting to see some fat chicks here...

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Sorry to disappoint Sam . Only fat ones here are MMs. The rest of us are lean and hungry traders.

Fox said:

I personally think that it is prudent to start imagining a huffing and puffing pregnant elephant when the spot has moved 1 standard deviation. After moves of two standard deviations or more, chances are the the elephant is puffed out.

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Agree. Especially like it if I can time it after a long sprint so when the elephant starts really slowing down, I can put on a credit spread ready for the retracement. Does'nt always work ofcourse. What has been working for me of late is adjusting each side seperately once the elephant has had a dash, could just be the way the market is moving but nevertheless Iv'e found it more fruitful.

Once the winning side has reduced enough I'll take off for a quarter or so leaving the other side to manage seperately. If the elephant pulls back as expected I can profit handsomely on both sides, if not I'll continue managing with the aid of theta & added protection in place.

Grinder said:

... added protection in place.

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Hey Grinder, I notice that you utilise protection a lot. Is this because adjusting (ie. cutting deltas) may not be possible at times? Especially in fast moving markets?

For example, I was at a point this morning where I would consider cutting my delta if XJO moved 25 points lower from yesterday's close. When the market opened, it immediately fell 80 points and I could not possibly adjust on time. Having protection would have prevented such a fast and large loss.

Protection of course, comes at a cost. But the benefit (of protection) is to prevent mishaps when large moves overnight prevent you from adjusting deltas at critical points in spot price movements. Is this how you see it as well?

R:R
Mean reversion is great...until it doesn't

mazzatelli said:

R:R
Mean reversion is great...until it doesn't

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Your not wrong. Happen to work a treat this time round.

Fox said:

Hey Grinder, I notice that you utilise protection a lot. Is this because adjusting (ie. cutting deltas) may not be possible at times? Especially in fast moving markets?

For example, I was at a point this morning where I would consider cutting my delta if XJO moved 25 points lower from yesterday's close. When the market opened, it immediately fell 80 points and I could not possibly adjust on time. Having protection would have prevented such a fast and large loss.

Protection of course, comes at a cost. But the benefit (of protection) is to prevent mishaps when large moves overnight prevent you from adjusting deltas at critical points in spot price movements. Is this how you see it as well?

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Kind of. Don't do much adjusting on days of big moves, tend to add protection on flat days or pick up protection when I open my positions, all with the intention to mitigate loss on big moves or fast trending markets.

Eg: I had a boat load of ICs with different strikes across 2 months over 3 indexes a few days back which were all close to delta neutral. All showing some profit, decided to close some, take off call side of others and halve a few others. Since then, market fell a fair bit spiking IV which would've had me alittle concerned about existing positions.

With added protection in place it has allowed me to stay in the positions longer, giving me every opportunity to have my positions turn a profit.