Being a trader is a challenging but rewarding job.

Hence, in any career, there are both highs and lows, triumphs and disasters.

One of the most rewarding days in my career was being able to exploit the dislocation that occurred in the markets.

When the UK left the European exchange rate mechanism in September, 1992, in a vain attempt to stop sterling falling outta the fixed FX regime, the UK government increased interest rates from 10 to 12% in the morning and from 12 to 15% in the afternoon with effect. From the following day, the markets were unimpressed and the government abandoned the UK's membership of the ERM. That evening, the government's economic credibility was destroyed overnight, paving the way for labor to win a landslide of the 1997 general election.

Despite the fact that the economy was doing well, that day was extremely volatile.

With markets seesawing constantly.

Conditions were made even more unpredictable in the interest rate markets because it was future's expiry day and traders had to roll their positions on that day.

My bank lent money overnight at 100% and one month money at 33%.

I was able to arbitrage the interest rate and FX derivative markets by effectively lending money in Sterling for three months at 16.5%, while simultaneously borrowing it back at 16%.

Normally, such arbitrage deals were only capable of generating a few basis points of profit, not 50.

One of the truly successful traders I met in my career was adept at taking a lot of risk.

He often said that if you want to have a hedge, you should buy a garden.

In other words, hedging is for wimps.

What I learned on the worst trading day of my career was that you cannot hedge apples with pairs.

Many products that banks trade are linear, such as cash, equities, and foreign exchange, other instruments such as options and non-linear and multi-dimensional.

The scenario I find myself in was being long of medium dated options on interest rate swaps.

If you are long of options, you need the markets to move in order for the options to become more valuable, or you need implied volatility to increase to make them more expensive.

If nothing happens, you lose money every day.

This is known as negative time decay or negative theater in order to ameliorate the negative time decay.

It was suggested to me that I sell some short dated options on UK Gil Futures to earn some premium back and reduce the effects of the negative theater in my naivety.

I accepted the suggestion, however, selling short dated options exposes you to large swings in delta, the probability of exercise when markets are volatile.

In addition, I was attempting to hedge options on five year swaps with options on 10 year government bond futures.

They're not the same instruments.

This was a scenario replete with danger, and so it proved on a day of extreme market volatility, I lost a lot of money, attempted to control the risk of my short options positions.

Whilst my longer dated options did not increase in value, I learned a powerful lesson.

Understand your risk properly and know whether you really have a genuine hedge or just another set of risks.