DAHF Boundary Conditions
These boundary conditions, or option risks has been compiled in the spirit of detecting and measuring all possible systemic hedge fund risks that pose a threat to the long-term health of the autonomous hedge fund.
The devs will make an effort to create code to detect these risks and prevent them.
Portfolios that generate boundary risks will be flagged for modification or removal, or if the root cause can be prevented in the biblepay finance virtual machine, routines will be added at that level to prevent execution of trades that violate boundaries.
- Call Exercise Risk
- No trade should be proposed or executed where less than .25 cents of extrinsic value exists on short calls. The resulting trade would trigger potential hard-to-borrow stock, short dividend risk, manual trades by an administrator, broker unhappiness, forced stock buyback (and delta risk), cash flow problems, or merger-and-acquisition risk. We must also monitor for short call extrinsic value day-to-day to avoid these risks.
- Put Assignment Risk
- No trade should be proposed or executed where less than .25 cents of extrinsic value exists on short puts. The resulting trade would potentially trigger manual trades by an administrator, interest rate charges (assessed on borrowing costs for the long assigned stock), and cash flow problems. We must monitor for short put extrinsic values day-to-day to avoid these risks.
- Counterparty Risk
- No trade should be proposed or executed where we are net long with an untrusted counterparty. An example is being short VIX and long a triple leveraged synthetic note such as UVXY. Or net long a bankruptcy candidate. Or net long options exposure on a short credit position for a hard-to-borrow or bankrupt stock or note. We must monitor the net exposure per symbol and compare against a blacklist daily.
- Vega Risk (Market Crash Risk)
- We must ensure the portfolio is not acutely sensitive to war or a market crash. An example of a bad idea would be to have 100% naked shorts on volatility (such as VIX or UVXY) two years out. Or being short vega would expose us to market crash risk. The portfolio should be greek hedged for vega, so that we are mildly long vega, and on volatility trades, not subject to systemic war risk. The portfolio must be programmed to detect vega risk for standard non volatile symbols, and specifically stress test any volatility trade to ensure the trade does not have unlimited downside during a war.
- Overtrade Risk
- We must ensure the portfolio manager program will not execute an unlimited number of similar trades.
- Analysis Weight
- We must assess a portfolio on many facets, not just ROI. An example is if we give a weight (from 1-10) on single attributes of a portfolio monte carlo simulation, with homogenized total weight that more accurately reflects the risk of the black-box. An example is: A weight of 8 for total drawdown, a weight of 8 for ROI stability, a weight of 7 for the portfolio ROI itself, a weight of 10 for boundary condition violations, etc. The weights may be summed and averaged, and the entire portfolio given a score. The score determines its position in prod.