Hedging question

[Profitaker]

Delta hedging (which is what you are proposing) takes no account of changes in implied volatility for example.

True, but at expiry the implied vol (time premium) is zero, and the delta is either +1 or -1, which is what's been hedged.

So if you sold a straddle, and the underlying didn't move but vol jumped up hugely, you would still be looking at a paper loss

In theory yes, but in practice the IV wouldn't spike without any move in the underlying.

 

[Silent.Trader]

In theory yes, but in practice the IV wouldn't spike without any move in the underlying.

I disagree on this one. IV is an indication of expected price movement. If a relevant message is expected eg a company announces a press crelease (unexpected) there's a fair chance the price won't really move. But a significant move may be expected and IV increases. It may very well be that only after the release, when the content is known a significant move in price occurs while IV may well implode despite the significant price move.

regards
Wilco

 

[Profitaker]

If a relevant message is expected eg a company announces a press crelease (unexpected) there's a fair chance the price won't really move.

Sure, that would cause an IV spike possibly without much SP movement. But realistically how often does that happen ? Significant corporate and economic events are normally documented well in advance.

However, unexpected news (good or bad) may well cause the IV to spike, but would also move the SP too.

GJ

I agree your point(s).

I suppose the decision as to whether to hedge dynamically or statically (or at all) depends on a numerous factors. When short far dated the Vega may be significant enough to hedge with options. I tend to short only front month options where the vega risk is bearable.

 

[garethb]

Reactor,

I think you're losing sight of the basic principal that any combination of positions whichever you consider to be the original and which you consider the hedge will leave you exposed such that you make money if one set of circumstances happens and lose money of another outcome occurs. You need to take a view on what you expect and give yourself that exposure.

eg.

If you sell a FTSE 6000 put at current levels and FTSE then falls to 6000 you will be showing a loss. If you do nothing and FTSE falls further you will lose more. If you hedge with the same number of short futures and FTSE falls more and stays below 6000 you will make money as if holding a short 6000 call position. If however you take that hedge and FTSE moves back up to current levels you will lose again. If you take the hedge off at that point you will have gained the time value but will have lost money on the fall in the value of the hedge.

If at 6000 you sell about half the number of futures as you are short put options you will be roughly delta neutral, in effect having a short straddle at 6000. If FTSE doesn't move very much you will make money but if it moves rapidly up or down you will lose money.

You cannot hedge a short options position successfully simply by taking an underlying position if it reaches the strike and closing that "hedge" position if the option moves back out of the money.

I've got a useful strategy guide published by CME which gives an intro to which strategies fit which market outlooks and how to "morph" from one strategy to another if your view changes. Unfortunately I can't find the link but if you PM me an e-mail address I'll send it to you.

Regards

Gareth

 

[Profitaker]

You cannot hedge a short options position successfully simply by taking an underlying position if it reaches the strike and closing that "hedge" position if the option moves back out of the money.

Why not ? Isn't that what dynamic delta hedging is all about ? The final P&L depends on the path the underlying takes, which may or may not make the trade "successful".

 

[garethb]

Profit

If you read Reactor's posts I don't think he's proposing systematic delta hedging but hedging his risk of his short option expiring in the money with a single trade if the underlying reaches the strike and taking the hedge off again when it feels safe to do so.

Regards

 

[irishpaddypc]

Cant you guys figure a better way to prevent losses accuring on the 6000 strike ftse short puts without using futrs.?

Using Ftrs as hedge on that 6K put strike is playing with FIRE should footsie spike UP on all those hedges! The prems recieved will NOT cover the losses made by the hedge = melt down of account!. The LOOSING hedge will wipe out account! The loosing hedge now becomes a massive liability! especially if FTSE continues heading north. The margin will hit the ROOF and you may face a possibility of account being liquidated too. Did this scenario cross your minds? The ftrs are on DELTA ONE! Now you would have to find another hedge to hedge your losing hedge! Now you would be playing with dynamite!

Sorry to tell U this boys:. FTRS as "hedge" in the wrong hands is like a child playing with matches/fire.

Selling calls to cover your losses will put U deeper into the fire. And buying puts to offset your losses will shrink your account further! and you'll be giving away the prems taken in the first place! and to cap it all up you'll be giving away a big chunk in brokers fees too. Not to mention the hot flushes and cold swet and sleepless nites and heart/pulse racing. And what about the wife naggin about your hedges/risks, sleepless nites and could affect your sex life too and eating apetite, weight loss, mood swings, divorce, repossesion etc.....

Paddy

 

[irishpaddypc]

Hi,

I need advice on hedging and welcome any thoughts on my question.

Suppose I've written a put option but the underlying now is at the strike.

Suppose the underlying is a futures.

If I decide to short the futures to hedge and the market carries on falling, at expiration, if I close out the futures and get exercised by the option buyer, am I correct that my only cost is the transaction cost to put on the futures hedge as I can offset my gain on the futures with the loss on the option?

What other costs have I not taken into account?

Thanks for your time!

Reactor,

Have you done options for real cash or are you thinking of taking the plunge into options?

You need to find the correct underline to suit the option strat and also to suit your knowledge on options.

And NEVER use ftrs as hedge on options unless you really have to. cause ftrs are generally on higher delta to naked otm puts and they [ftrs] will eat up your account in one gulp.

Paddy

 

[gbr128]

Reactor,

The ftrs are on DELTA ONE!

You need to find the correct underline to suit the option strat and also to suit your knowledge on options.

Paddy

Ok, firstly futures aren't necessarily Delta-1. If you're looking for a perfect hedge then you should bear this in mind. Can run up to 1.25...

Secondly, if you're short a put the only hedge you can get to ameliorate all exposures is to buy a put. If you short a call (let's assume same expiry, possibly different strike) you end up short a straddle/strangle which may well make you delta-neutral for now but will result in you being short both gamma and vol.

irishpaddypc, please you could help us with how to dynamically hedge a short put with 'the correct underlying' ? I'm very curious, as apart from the underlying stock/index-future you're left with other options, unless you're really big size and you're worried about your rho and want to buy/sell and interest-rate swap or if your dividends exposure is to big and you want a dividends-swap....

Guess it all depends what one thought one's plan was when originially selling the put... did one expect prices to rise? To stay where they are? i.e. trying to be long-delta or short-vega?

 

[irishpaddypc]

Ok, firstly futures aren't necessarily Delta-1. If you're looking for a perfect hedge then you should bear this in mind. Can run up to 1.25...

Secondly, if you're short a put the only hedge you can get to ameliorate all exposures is to buy a put. If you short a call (let's assume same expiry, possibly different strike) you end up short a straddle/strangle which may well make you delta-neutral for now but will result in you being short both gamma and vol.

irishpaddypc, please you could help us with how to dynamically hedge a short put with 'the correct underlying' ? I'm very curious, as apart from the underlying stock/index-future you're left with other options, unless you're really big size and you're worried about your rho and want to buy/sell and interest-rate swap or if your dividends exposure is to big and you want a dividends-swap....

Guess it all depends what one thought one's plan was when originially selling the put... did one expect prices to rise? To stay where they are? i.e. trying to be long-delta or short-vega?

Sorry for the deletion, i have good reasons for my actions.

Paddy[/COLOR]

 

[gbr128]

Gbr,

I've been taught never to write put options unless you know the risks envolved and what puts to write. Knowing which puts have the best chance of heading to zero value.
Also how to deal with short puts that rise in value and how to convert. i've also been taught why its no good using ftrs as hedge on short puts and i have been shown a better way to deal with a rising short put position .
I cant give away more than i have as i have no permission to do so from my tutor, sorry. I hope you understand my situation.

Paddy

So assuming the the distribution of returns over the lifetime of the option is symmetrical (if not normal, see another thread for that) then the puts that have the best chance of heading towards 0 value are those furthest from the money, but you'll have to sell a shedload to make the same premium as one or two at-the-money puts. So far so good but now you're in real trouble if there's a big shift in the underlying downwards.

How to convert a short-put position with rising value? Do you mean to capture P&L as the underlying rises prior to expiry, basically to "bank it" ? Or do you mean swapping into a long-cash position and out of the short-put as the underlying rises? Or both? Or do you construct a chooser-like position with a combination of call/put at different expiries at the same strike?

Anyway, short futures/cash is a great delta-hedge vs. short puts but again it depends on one's reasons for taking the short-put position in the first place. Rubbsih vs. any of the other greeks. Depends what you want exposure to.

I think all readers of the thread would probably benefit if you could give away as much you feel you're able to. Bit of an empty read otherwise...

Personally I've forever too risk-averse to sell any option so very interested to learn ways of hedging other than just selling call/put and dynamically hedging the underlying.

 

[Profitaker]

No form of hedging is risk free. By definition the hedge must take on risk in the opposite direction to the original position. Whether to hedge with options or futures depends on many factors.

Generally, delta hedging a short options position in the underlying works better further away from expiry, where the gamma (change of delta) is much lower. As expiry approaches the change of delta can be overwhelming, resulting in the constant buying and selling of the underlying and consequent loss. As expiry approaches, hedging with long options may be advisable, where there isn’t much time value to pay.

Or of course you could do nothing and ride the storm, or you could liquidate. Not an easy decision and as always, no free lunch.


GBR

Not sure what you mean when you say that futures don’t have a delta of +1 ? The futures are linear and should track the underlying 1 for 1, although they can swing above and below fair value – is that what you mean ?

 

[irishpaddypc]

Sorry, i had to delete this post. My action for doing so are well founded imho.

To my surprise Mr frugi [modarator] deleted more of my posts and gave no reasons for doing so.
Paddy[/COLOR]

 

[irishpaddypc]

gbr,

One of the first lessons Bulldozer taught me is that information is the key to gaining /making wealth from the buyers. Also the WRITERS have MORE than 2 to 1 advantage over the buyers and the buyers are at a BIG disadvantage. Below are some points i learned:

1. Put writers WIN if underline goes sideways or Upwards. [2 TO 1 IN FAVOUR]
1B. Put buyers LOSE if underline goes sideways or Upwards [2 to 1 disadvange]

2. Call buyers LOSE if underline goes sideways or downwards. [ 2 TO 1 DISADVANTAGE]
2b. Call writers WIN if underline goes sideways or downwards ! [2to 1 in favour]
2c. And call buyers sometimes LOSE if underline goes Upwards too! so infact its 3 to 1 advantage to the WRITER and 3 to 1 disadvange to the buyers.

3. The call buyers need the underline to move in ONE direction [up] and it has to move ABOVE the purchased strike PLUS go past the premium level too before they see any profit.

4. If the underline goes up [ITM] in favour of the call buyer he can still lose because the premium were heavy from when trade was opened and altho positions may be ITM the premiums would still be showing LOWER than the value of PREMIUMS PAID! = LOSS + COMMISSIONS LOSS TOO.

Based on these knowledge alone i believe strongly that the writer has the edge over the buyer every time! be it short term or long term. Whats you view on this ? do you agree that the writer has more than 50% chance of making profits from these trades?
Also would you say there is more than 50% chance that the writer can make more than 10 trades on the spin! without showing a loss?

Paddy

 

[gbr128]

Profittaker: I've been reliably told that the credit you receive on a future when it rises and the interest you then receive on that credit will result in you getting more than 10% if the underlying rises 10%. Likewise if it falls 10% the trader will need to pony-up more margin on which they won't be earning interest (or will have to pay if borrowing) and so will lose more than 10%. At the moment of expiry the delta is exactly 1.0. Until then it's a bit more... I'm sure Hull explains it better than I do.

Paddy: 300-500 points out of the money? For some reason I'd been following this thread assuming ATM and hadn't realised you meant only European style index options. How far out do you write the option? 3 months? I guess a potential seller can look at the returns of the index and establish confidence intervals based on the historical moves and decide that, based on the past, they're N% confident of the M-point OTM contract expiring worthless. Is that along the lines of what you're doing? Do you also sell OTM Calls or are you Puts-only?

 

[jj90]

Selling [writing] 300-500pts OTM puts is not symmetrical. Also most peeps think its not normal position to be naked of 100-500 contracts. Thats mainlly because most dont know that EU have not risk of contracts be assigned/exercised/ before expiry day [FTSE index is EU style] Also they are cash settled.
Doing Aug 5725 puts would have given you over £600 per contract, and with it doing Sept 5625 puts would have given U over £600 per contract too, and doing Dec 5525 puts would also have given you over £700 per contract. Now put 100 contract on each what does it you in ££££

Now if you would have said that from the beginning, we wouldn't have blown up that other thread. It's a lot easier to understand when you give all the facts. From your quote, I can see your OTM strangle position on the FTSE index. By it being EU style, you can't be assigned, so you have the position till expiry. And by going far out, not only do you take in significant premium, but more importantly, you have time for the FTSE to rebound back in whatever direction into the profit zone. There is also the slower rate of change in deltas. The thing I have to say is, without going into repair strats (aka going long/short underlying, closing out the short position or whatever blah blah blah), you are basically betting that the FTSE will bounce back into the profit zone, in the time given. If you close out prior to expiry, you take the loss, but you don't and give it time. If the FTSE doesn't go your way, you step in.

 

[irishpaddypc]

Profittaker: I've been reliably told that the credit you receive on a future when it rises and the interest you then receive on that credit will result in you getting more than 10% if the underlying rises 10%. Likewise if it falls 10% the trader will need to pony-up more margin on which they won't be earning interest (or will have to pay if borrowing) and so will lose more than 10%. At the moment of expiry the delta is exactly 1.0. Until then it's a bit more... I'm sure Hull explains it better than I do.

Paddy: 300-500 points out of the money? For some reason I'd been following this thread assuming ATM and hadn't realised you meant only European style index options. How far out do you write the option? 3 months? I guess a potential seller can look at the returns of the index and establish confidence intervals based on the historical moves and decide that, based on the past, they're N% confident of the M-point OTM contract expiring worthless. Is that along the lines of what you're doing? Do you also sell OTM Calls or are you Puts-only?

Gbr,

I have imposed a 20 days ban on myself for many reasons, see Profitakers thread > "Options edge writers vs buyers" This will show you my reasons for the ban. Also because many of my posts are being deleted by Mr Frugi without first telling me and then gives very poor reasons for doing so.
I'm not prepared to show my trades on this forum because there are people on here who dont even deserve the air they breath [i'm not saying your one of them] i think when you read that thread you'll understand why.

http://www.trade2win.com/boards/showthread.php?t=17620

http://www.trade2win.com/boards/showthread.php?t=16863

I will be deleting most of my posts on options so please dont be offended by my actions, i believe i have good enough reasons for this corse of action. I may contact U by PM in future.

My main reason for visiting the options threads is to expose the errors some members are posting on options that could lead new/old members in deception and could lead them into huge losses in short/long term.

I may decide not to return after the 20 days are over and impose a longer ban like my uncle [bulldozer] did.

Best wishesand happy trading.

Paddy

 

[garethb]

Reactor

Found a link to the strategy guide I mentioned a few days ago

http://www.cme.com/files/M417-1F&OStrategyGuide.pdf

Regards

 

[Profitaker]

Profittaker: I've been reliably told that the credit you receive on a future when it rises and the interest you then receive on that credit will result in you getting more than 10% if the underlying rises 10%.

I see what you mean. But the future should move 1 by 1 with the underlying , the delta is always +1.

The futures can swing above and below fair value. If you know what the fair value is you can sometimes gain an edge this way.

 

[reactor]

Getting back on course, spiking is a good point that I haven't considered that could happen if I have a futures hedge on. I'd just have to close out the futures and take the loss on the hedge if this happens.

I've had a look on the CME pdf file for strategies, which was interesting.

Keep up the good contributions!