Traders Beware: Avoid Over-Hedging

Traders Beware: Avoid Over-Hedging

Posted On April 5, 2022 3:33 pm

There are two-well known sayings among traders; the first is from the famous book Reminiscences of a Stock Operator , which chronicles the life of legendary speculator Jesse Livermore in which he states, It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight!”  

The second is that, “there is no such thing as a perfect hedge,” which is a more general investment world saying. 

I thought about these two notions following my foray into online gambling.  After watching the Miami Open Tennis Tournament finals. It featured an 18-year-old Carlos Alacraz taking the tour by storm. He moved from number 145th a year ago to 11th in the world. Despite being ranked 16th and his opponent, the #5 Casper Ruud, Alacraz was the odds-on favorite to win. 

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I was also curious to see how the casinos now offer real-time updates and the ability to place new bets while the game is in progress. Yes, I hadn’t bet on sports since college, so this seemed like an amazing ‘new’ thing to me. And of course, it wasn’t lost on me that this created a dynamic market that allows real-time ‘trading.’ 

So, on Sunday I opened an account on DraftKings (DKNG) and settled into my La-Z-Boy.  The initial odds had Alacraz 3:1 favorite, meaning bet $3 to make $1. I didn’t place an initial bet because while I liked Alacraz to win I didn’t like those odds.  But then Ruud broke him on his first service game to go up 2-0.  (For those non-tennis fans, matches hinge on holding your own and  ‘breaking’ your opponent’s serve).  Suddenly, with Alacraz down a break the odds went to 1:1 or even money. I liked those odds and made a small bet. The match progressed and Alacraz broke back and ended up winning the first set–it was a best of three match. Now I was offered the prospect of betting on who would win the second set with Alacraz back to being 3:1 for the set.  Meaning I could ‘hedge’ my initial bet that Alacraz would win the match by betting on his opponent to win the second set; bet $1 to win $3, which I did. Long story short, Alacraz won the second set and the match and I broke even. 

It quickly dawned on me that sometimes I fall prey to this type of over-hedging in my trading. As Livermore said, I would have been better off, “sitting tight!”  

I was also surprised DKNG’s site actually stopped taking new bets in the middle of the second set, which seemed strange; how did they know there wouldn’t be a third set? This struck me as a sign it was a very illiquid market, which would also explain that huge swing in odds after just the second game. I mean who the heck bets on tennis? Suddenly, I was having flashbacks to our recent trade in my in my Options360 Concierge Trading Service in the stock Deere (DE) (I described this trade here), where the lack of liquidity in the options essentially created a “no more bets” situation causing us to stay in a position longer than I should have. 

The main takeaways were wait for good set ups, stick to your plan and only hedge if it truly locks in a gain. These are things I already knew but are sometimes hard to stick with, especially during volatile markets.  I also realized I’m better off spending money on a lesson to improve my forehand than gambling on sports. 

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About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.