Risks and Hedging Challenges in Large Short Strangle Positions

Summary

The document raises a risk-management question about a reported PIMCO trade involving large short positions in an S&P 500 put and call strangle. It asks how other market participants might hedge long option exposure against a seller of that scale, especially if volatility rose and those traders had less capacity to absorb losses.

The post reports that the trade generated a large premium and ultimately expired worthless, yielding a profit for PIMCO. It does not provide a hedge design, market data, or analysis of how counterparties actually managed exposure. The outcome is presented as possibly reflecting luck or a lack of traders willing to take the other side, rather than evidence that the position was safe. As a result, the material is most useful as a prompt about asymmetric capacity, counterparty concentration, and short volatility risk; it does not establish a general hedging method or explain the trade’s risk profile in depth.

Key ideas

• Large short strangle positions can raise questions about how counterparties hedge their long option exposure.
• A volatility increase may pose a greater capacity challenge for traders with less capital than the large seller.
• The reported position expired worthless, but that outcome alone does not show that the trade was low risk.
• The document poses the hedging question without providing a specific strategy or empirical analysis.

Tags

# How were very large short volatility positions hedged?


# How were very large short volatility positions hedged?












This question came from an actual trade occurred in about 2014 when PIMCO sold very large positions in SPX 1840 put/1920 call strangle. It was reported the premium alone was worth \$100 million (they opened another similar but smaller strangle position). According to the book Bond King, everyone was talking about this trade when the trade was still open.

So the question is, when there was such a large short volatility trade, how would traders hedge their long positions againt PIMCO's short strangle? PIMCO had no capital constraint problem even when volatility rose dramatically (let's assume they didn't have such constraint for brevity), but not necessarily to other traders.

Just a side note, the strangle expired worthless in the end so PIMCO made a huge profit in this trade. Maybe luck or maybe no one wanted to challenge the trade.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.