Hedging

[Jack o'Clubs]

For CMC that sounds right. It just the same as their spreadbet platform so you can open a position of any size you like.

Is IG offering DMA CFD's? If so, that would make sense as they would only offer the CFD in multiples of the futures contract that they would offset. Otherwise seems a bit odd.

Presumably then CMC CFDs are taken on against them as the market-maker, and not automatically hedged in the market.

 

[the blades]

For CMC that sounds right. It just the same as their spreadbet platform so you can open a position of any size you like.

Is IG offering DMA CFD's? If so, that would make sense as they would only offer the CFD in multiples of the futures contract that they would offset. Otherwise seems a bit odd.

Presumably then CMC CFDs are taken on against them as the market-maker, and not automatically hedged in the market.

yep, think you're right. So I can fluently manage my exposure with CMC, at the risk they'll not honour the contract in disastrous circimstances.

I'm favouring Futures contracts for the majority and a CFD or EFT to trim around the edges

A nice little thread with a happy ending, I hope.

Cheers fellas.

UTB

 

[grantx]

UTB,

“So if (for eg) I held £100K of UK stock I'd take a down bet on the FTSE of (£100,000/6600) £15 per pt, or an equivalent futures bet.”

I stand corrected on this (that’s a qualifier for, “do I know wtf I’m talking about?”), but isn’t this hedge actually neutralising your portfolio? What you lose on the stocks in a sell-off you gain on the down bet; what you gain on the stocks on a rally, you lose on the down bet? Net = zero.

To repeat, maybe you should look at selling options against your stocks.

Grant.

 

[the blades]

UTB,

“So if (for eg) I held £100K of UK stock I'd take a down bet on the FTSE of (£100,000/6600) £15 per pt, or an equivalent futures bet.”

I stand corrected on this (that’s a qualifier for, “do I know wtf I’m talking about?”), but isn’t this hedge actually neutralising your portfolio? What you lose on the stocks in a sell-off you gain on the down bet; what you gain on the stocks on a rally, you lose on the down bet? Net = zero.

To repeat, maybe you should look at selling options against your stocks.

Grant.

Grant,

You're right fella. If I make 10% on my protfolio but the index rises 15%, I lose 5%, simple as.

It all hinges on my outperformance....hopefully. I've demonstared this over the last 5 years, and backtests over many more support my theory, for what that's worth.

I'm "expecting" (praying for ) long term returns of 30% per year, with an index return of upper single digits. In theory if the markets tank, correlations should rise and they all fall "in line".

Unfortunately I haven't operated in a bear market, time will tell?

Re options - i suppose I don't know what I don't know. Could you recommend a starting point for a thick Tyke like me?

UTB

 

[Jack o'Clubs]

Re options - i suppose I don't know what I don't know. Could you recommend a starting point for a thick Tyke like me?

UTB

Getting Started in Options (Thomsett) is a decent primer. About a tenner on Amazon. Covers everything you're likely to need to know including a basic portfolio hedging strategy. The problem I have is that unless your focus is large caps, options are either an expensive or non-existent form of insurance. Most US stocks have traded options, so the issue there is just premium/spread, but in the UK once you drop out of the FTSE100 (and even within it) it can be hard to find an options market. Grant or others with more experience of stock derivatives: please correct me if I'm wrong!

 

[TheBramble]

Blades was talking about taking a spreadbet on the FTSE index to hedge his ‘proper’ portfolio so I’m guessing the index provides a reasonable proxy for his portfolio rather than needing an precise match for an exotic basket, so it wont be that hard to find an option to fit.

 

[Jack o'Clubs]

Blades was talking about taking a spreadbet on the FTSE index to hedge his ‘proper’ portfolio so I’m guessing the index provides a reasonable proxy for his portfolio rather than needing an precise match for an exotic basket, so it wont be that hard to find an option to fit.

A-ha. Although I thought Grant was talking about specific stock option hedging.

So have I got this right? I have a portfolio of £66,500 (ie the index value, to keep it simple) which I want to hedge with FTSE puts. So I buy a December 08 at-the-money put, currently quoted at 480, so it costs me £4800 (7.2%) for more than a year's insurance. Seems a reasonable deal to me unless I've got my maths wrong somewhere...

 

[the blades]

A-ha. Although I thought Grant was talking about specific stock option hedging.

So have I got this right? I have a portfolio of £66,500 (ie the index value, to keep it simple) which I want to hedge with FTSE puts. So I buy a December 08 at-the-money put, currently quoted at 480, so it costs me £4800 (7.2%) for more than a year's insurance. Seems a reasonable deal to me unless I've got my maths wrong somewhere...

ok - pardon my ignorance - a £10 bet on a quertelry contract would could me about £40 in spread. A futures contact would cost much less than that. Is it worth the effort to get into options?

I suppose £40 would pay for 4 copies of the book

UTB

 

[the blades]

Blades was talking about taking a spreadbet on the FTSE index to hedge his ‘proper’ portfolio so I’m guessing the index provides a reasonable proxy for his portfolio rather than needing an precise match for an exotic basket, so it wont be that hard to find an option to fit.

that's my thinking, yes.

UTB

 

[Jack o'Clubs]

ok - pardon my ignorance - a £10 bet on a quertelry contract would could me about £40 in spread. A futures contact would cost much less than that. Is it worth the effort to get into options?

I suppose £40 would pay for 4 copies of the book

UTB

The difference (assuming my maths was right) is:

Futures Hedge: Your performance - FTSE performance = net performance
Options Hedge: Your performance - 7.2% = net performance

So... if the FTSE is going to perform better than 7% in a year, you're better off with the option hedge. I guess it's a close call.

EDIT: Although to be accurate, 14 months 'insurance' at 7.2% annualises at just over 6%. Also, if it ends up close to the money, there'll be some residual value with a few days/weeks to go so you can get something back for short-term volatility. On the other hand with the future, you're getting the benefit of the implicit interest. Crikey, my head hurts...

 

[the blades]

The difference (assuming my maths was right) is:

Futures Hedge: Your performance - FTSE performance = net performance
Options Hedge: Your performance - 7.2% = net performance

So... if the FTSE is going to perform better than 7% in a year, you're better off with the option hedge. I guess it's a close call.

and funnily enough I have an average index performance line in my "backtester" which right now suggests a return of 7% per year since 1998!

I'm a lazy bugger. I'll stick to what I know.

Cheers all,
UTB

 

[grantx]

Gentlemen,

I should have been more specific. Stock positions should be hedged via short calls, ie if long XYZ stock, sell XYZ calls. This provides a degree of – not absolute - protection on the downside. However, it also increases the overall yield of a stock – add the premium received for selling the call to any dividend. In outline, if you sell a call, you’ll receive money (premium). This will really boost your annual yield, UTB.

Now compare buying puts as protection. This provides (almost) total protection against downside risk but you will have to pay the premium (compared to receiving the premium on a short call). Therefore, the net is a debit, thus reducing any positive return on the stock.

Given UTB’s “Yorkshireness” (probably a Yorkshire farmer with it – short arms, deep pockets), this should appeal to his sense of “value”.

Touching on Jack’s comparison re futures/options performance, I think this is a question of certainty of a lower return vs uncertainty of a higher – or no - return; and given UTB’s objective of a positive (minimum) annual yield, the certainty of a lower return may be more appropriate.

Options cover around 85% (?) of FTSE 100 constituents; I doubt there is anything for FTSE 250 stocks. And I may add, the premiums appear to be sky-high. In other words, it is very much a seller’s market. Fill yer boots, UTB.


Grant.

 

[TheBramble]

For outrights like us, the preference would obviously be toward grabbing (selling) premium. But I don't think Blades is into scraping additional income from his positions - I get the sense he's looking for security through paying for absolute or nearly delta protection. He'll need to buy those options.

 

[grantx]

Mr Bramble,

On my initial reading of UTB’s posts, “index return of upper single digits” struck me. My impetuous nature lead me believe this was his target, hence my options strategy.

However, prior to launching a tirade of abuse in response to your post, I thought I’d better re-check. And what do I find? “long term returns of 30% per year” (assuming a continued bull run) with negative correlation (?) if the market dives. I can’t see how this can be done consistently, on a conservative basis.

My apologies for the anticipated abuse.

Grant.

 

[the blades]

Mr Bramble,

On my initial reading of UTB’s posts, “index return of upper single digits” struck me. My impetuous nature lead me believe this was his target, hence my options strategy.

However, prior to launching a tirade of abuse in response to your post, I thought I’d better re-check. And what do I find? “long term returns of 30% per year” (assuming a continued bull run) with negative correlation (?) if the market dives. I can’t see how this can be done consistently, on a conservative basis.

My apologies for the anticipated abuse.

Grant.

Tony - I pasted your response into spell checker, then realised I didn't know what language it was written in?

Seriously your response has tipped me to the edge of at least trying to understand the first thing about Options. Right now, it's double dutch to me.

Grant - I find your lack of faith disturbing (in Darth Veda voice)

But again to be serious, I'm not looking to make 30% if the market tanks. But I am aiming to outperform the index by 20 - 25% (ie make 15% if the market falls 10%). This might well be fanciful but that's for another thread

UTB

PS Tony - as a yorkshireman I'm allowed to take the **** out of Yorkshire. You're not. Watch those knee caps fella

 

[grantx]

UTB,

Forget my last post and lack of faith (breakdown in communication) and re-focus on #32.

Options are complex but only for complex situations. Your aims are met by the fundamentals with no need to venture into the realms of gamma neutral/vega positive cluster regression (I just made that up). You’ll do better with this approach compared to Set-aside/sugar beet crop rotation.

Never mind Mr Bramble, he tends to speak in “tongues” occasionally.

Grant.

 

[TheBramble]

What I thought I said was:-

“Blades doesn’t want to make money by taking the premium from selling an options position to cover his portfolio. He wants to cover his portfolio roughly in line with any adverse movement against it by offering a premium in buying an options position to cover his portfolio.

If he’s Long a basket of stocks, I imagine he’ll want to BUY a PUT on the FTSE Index, in the money or certainly on the ITM side of ATM in order to get a near perfect delta (change in value of underlying implies same or nearly same change in value of derivative). If his portfolio declines in value (bad news if you’re Long), his PUT will increase in value roughly to the same and opposite degree (assuming the Index option is a close proxy for his basket) as the cumulative value of his basket.

If he’s Short a basket of stocks, I imagine he’ll want to BUY a CALL on the FTSE Index, in the money or certainly on the ITM side of ATM in order to get a near perfect delta (change in value of underlying implies same or nearly same change in value of derivative). If his portfolio increases in value (bad news if you’re short) , his CALL will increase in value roughly in to the same and opposite degree (assuming the Index option is a close proxy for his basket) as the cumulative value of his basket.
He wants to pay an insurance premium to give him a measure of protection against major bad news.

He doesn’t want to augment his outright position by compounding it with a sale of premium in the same direction as his portfolio.”

I appreciate I’m not necessarily the clearest chime in the belfry at all times and maybe that primer would be a good idea anyway, but I’m fairly sure that’s what I thought I said...

I am deeply hurt by the aggressive and openly hostile response to my previous post.

 

[TheBramble]

no need to venture into the realms of gamma neutral/vega positive cluster regression

Well it's strange you should venture that only in that gamma neutral may be exactly where Blades wants to be, but he'll need to achieve his annual target first! Being gamma neutral in wild times when you've got what you want is exactly where you'd want to be. If there are over-arching reasons why you couldn't get out completely of course, and in wild times, that's reason enough. Slippage can make a mess of even a 30% profit and in fairly short order too…

The vega positive would be an issue to consider given my previous post suggesting he take ITM or ITM side of ATM and especially if we’re talking about a years’ worth of ‘insurance’. It’s precisely that combination of long duration to expiry and proximity to ATM that will tie in with any increased Volatility that wild times brings (and Blades wants to guard against – but only if it’s wild AND against his portfolio) that will lead to a vega positive position. But as Blades ain’t trading options for gain, but only for insurance, it’s never going to be an issue.

 

[TheBramble]

PS Tony - as a yorkshireman I'm allowed to take the **** out of Yorkshire. You're not. Watch those knee caps fella

Listen chap, I have connections with the Skeeby Mafia so don't get on thy high horse or I'll 'av whippets attack launched.

By gum. (That wasn't a market order...)

 

[TheBramble]

As I’m here, I’ll continue…

Why I think Blades, you may be into a diminishing returns for effort and energy situation (I think you’ve already recognised that a day or so back and why you indicated you’ll carry on as you have been) is that it’s going to be a little difficult for you to assess your portfolio on a dynamic basis to the degree necessary to determine precisely the corresponding options play to counterbalance your investment and protection aims at every point in time during the life of your trade.

Your basket will unlikely directly correspond in the constituents or constituent weightings to the index, and that’s even if you only chose stocks which are constituents of the index. If you select an improper subset (some stocks not included in the index) your assessment becomes slightly more difficult and prone to inaccuracy, but the process is exactly the same.

You’d need to calculate the correlation between your portfolio and the index on a daily (or more frequently) basis. And unless you’re planning on getting into the micro adjustments necessary to reflect even a static basket of stocks (and I assume you may add and delete as time passes) your options leg is going to get out of whack.

All of this is in addition to the initial hurdle of deciding how much cover or insurance you want. You could make a thesis out of just one trade, but I suspect, a rough guide is all that’s necessary should you choose to go down that route and Grantx has already suggested an example scenario that would meet your needs in principle (he must have done that by accident because it was quite good).

I thought I was pretty risk averse, but your caution, diligence and efforts in protecting your portfolio leaves me thinking my risk management is positively buccaneer!