Scenario discipline: pre-computing the worst day

After this lesson you can work out what a realistically bad day would do to your book, ahead of the day itself.

The question professionals ask nightly

Every serious risk desk ends the day with a version of one question: if tomorrow is terrible, what happens to this book? Course 1's heat number is the first-order answer: all stops hit, −3R, survivable. This course adds the second-order honesty, because School II, course 6 taught you why "all stops hit" is the optimistic bad case. Stops assume an open, orderly market, and the genuinely bad days start with gaps.

The scenario drill, run weekly (and always before earnings season):

One — the event inventory. For each position: when does it report? Any scheduled binary (regulatory decision, product event)? The calendar dates go next to each line of the heat table. A book where four of five names report within the same week is running a concentrated bet (course 2) that the heat number can't see.

Two — the gap-case arithmetic. For each position through an event night, price a realistic bad gap: the kind of opening drop that stock's class of name actually produces on a bad report. School III, course 6's ADR gives you the scale, and high-volatility names gap hardest. A position risking 1R to its stop might realistically cost 2.5–4R through a gap. Sum the book's event-week exposure in gap terms and set it beside the heat total. The two usually disagree.

Three — the correlated-day case. The 2020-style morning (course 2): everything opens down together, index-led, no stock news at all. What does the book lose if every position gaps a correlated chunk and every stop fills late? This number is why the heat ceiling exists at 3R rather than 10R, and computing it occasionally, actually writing it down, keeps the ceiling from feeling arbitrary during the enthusiastic weeks when it binds.

Acting on the numbers

The drill's outputs map to decisions already in your toolkit. Event-week gap exposure too high → trim before the reports, or skip holding through them at full size (School II, course 6's defense, now applied bookwide; a position can be a fine hold and still be a bad hold on the night it reports). Correlated-day number frightening → the theme caps or the heat ceiling are set too loose for this book's composition. Pricing the scenario is also what keeps the exercise from being worry. Once there's a number attached, next week's possible emergency turns into a small adjustment you make this week.

Run the drill weekly against your own book: list what is scheduled, work the gap arithmetic, and write the number in your journal where next week can read it. Most weeks it's thirty seconds of division that changes nothing.

Check yourself

1. Heat says −3R worst case; the scenario drill says −7R this week. What explains the gap, and which number governs event-week decisions? (Three positions report this week — gap risk prices in multiples of R that stops can't cap. The 7R governs; trim or accept it knowingly.)
2. Why does the correlated-day computation justify the heat ceiling? (Because on the day correlations go to one, the whole book gaps together — the ceiling was sized for that day, and pricing it occasionally is what keeps the ceiling respected.)
3. What turns scenario work from anxiety into discipline? (Writing numbers and pre-made decisions. Once a scenario has a number on it, you can plan around it instead of waiting to be surprised by it.)

The habit this lesson installs

Price the bad week before it happens — a scenario with a number attached is a plan.

Next: Course 6 — "Sizing for the bad year."