macrocephalopod

liquidity is terrible, why are they doing this? Well, they have to. Won’t it cause the price of ABC to crash further? Yes. And the faster it crashes the more Dealer Z (who is now short gamma) has to sell. This is often how those crazy moves you see near market bottoms happen.

Anyways: Crodeet Swish and Dealer Z come to an arrangement, net their positions out, and the residual gets paid to Joe. It’s over.

Postscript 1: This is why I don’t subscribe to narratives of “capitulation” or “retail throwing in the towel” or “mass panic”. None of what happened is affective in nature, all of it is just a necessity of the structure of that market under a particular set of conditions.

Post Script 2: If John had bought a 3x note before Joe bought his 2x, John’s would have knocked-in first, and the hedging by Dealer Z could have caused the price to move lower and knock-in Joe’s. This is what a cascading crash or waterfall market is, in effect. It’s all mechanics

Post Script 3: Dealer Z may not have wanted the risk, so Crodeet Swish could have had to find an alternative buyer for it by structuring it so that the premium was paid as a coupon to someone willing to take that risk. This called “tail risk recycling” see also: autocalls. Fin.

This is a v interesting thread but 1 thing I don’t get — how is a knock-in put where the barrier is between the strike and the current price any different from a regular put? The prx must go thru the barrier on its way to the strike, if it expires ITM it must have been knocked in

a barrier not breached essentially models like a 1DTE vanilla, so binary. you essentially do no hedging until you are very very adjacent to the strike and your gamma is very volatile. in practice you essentially don’t hedge in vanillas at all until its breached

Huh my brain must be broken. I feel like a put with strike < spot and a knock-in-put with strike < barrier < spot have the same payoff in all states of the world, so they shd have the same greeks and be hedged in the same way.