Cheapest way to hedge against catastrophic event

Discussion in 'Options' started by jtrader33, Aug 4, 2011.

  1. I'd like to address the business risk of some unprecendented event causing a broad market gap down of 30-50% while I happen to be sizably (for me) net long. I'm not concerned about the upside, or even a significant sell-off that doesn't come in the form of a halt/massive gap. The most obvious answer is to buy some puts but that feels expensive. I'm wondering if anyone is aware of some exotics that are available at the retail level where I could get a more customized and therefor cheaper structure. Short of that, I guess the question becomes what is the best solution if using vanillas only.

    The other issue is that I need to decide if I put the hedge on and take it off as my market exposure crosses above/below some threshold level...the alternative being that I just buy some protection and let it sit regardless of the market exposure of my strategies. All else equal, it seems appropriate to only put the hedge on when needed but there's one key issue with that: it's not all that common, but i can swing back and forth between sizable net long / net short exposure multiple times in a given trading day = bid/ask + comms adding up. That said, if I'm stuck using vanillas and want to hedge dynamically, the best idea I've come up with so far is leap puts. Less decay, and the smaller gamma will create less of a pnl effect with 'normal' intraday market moves (will size it based on notional rather than delta), but if a catastrophic event occurs they perform similar to delta 1. That kind of feels like crappy logic though, replacing a tiny bit of pnl vol with vega risk. Anyhow, brain is fried from this week but hopefully that's somewhat readable. Would be great to hear if anyone has thoughts on the above or alternatives.


  3. 30-50% ??????

    LOL ....... You have a greater chance of getting hit by lightning than experiencing such a drop in the markets. Could you please post something more sensible, this is EliteTrader.

    I put the Elite in EliteTrader.
  4. Appreciate you bringing your omniscience to the thread. Close-to-open the market dropped ~10% after 9/11. What's your market on where we open if a dirty bomb goes off in Manhattan or someone takes out the bridges/tunnels?
  5. VXX ratio bull spread (or whatever the name). ex. you buy 2 VXX calls strike 44 for 0.8 each and finance the position by selling 1x VXX call strike 40. these are Sept calls. basically you have almost a free position that will pay handsomely if the market drops 30% because you will have unlimited potential on 1 of your 44 calls.

    you will have to deal with the position if VXX is between 40 and 44 but that's a small price to pay.

    BTW the market is down 10% in the last 2 weeks and that's before any bombs went off :eek:
  6. spindr0


    The better the insurance, the greater the cost. The best insurance is outright long puts. Loss down to strike plus premium paid.

    If you want to diminish that cost, you have to give up something in return. Some positions will give you partial downside coverage (various put spreads) or perhaps you give up some upside (collars) in retrun for lower cost outlay yet same protection as long puts..

    Backspreads > than -1 to +2 might be interesting because the out of pocket wouldn't be that large and in the event of a big crash, you'd make some net gains despite your long UL losses. The problem would be a drop to your short strike.

    It all depends on where your risk graph comfort zone is.
  7. spindr0


    Did you mean puts? If not, I need to read a book :)

    1:2 is fine for crash scenario but ratio must be higher if looking to hedge long portfolio well as OP wants.
  8. It's happened at least twice in the last decade or so.

    Strikes me as slightly more probable than lightning...

    The best insurance, and the only one guaranteed to work, is to not be in the market at all.
  9. ratio backspread calls on VXX, not puts.

    actually VXX is not a good idea since if whoever issued VXX (Barclays?) goes down VXX seizes to exist (so i have read).

    ratio backspreads on VIX front month calls should do the trick. unlimited gains vs backspread on SPY puts = limited gains.
    he wants a catastrophe insurance
  10. it has happened twice in the last decade? can you tell me the two instances where the market gapped down 30-50% at open?

    i'm sure you can't because it has never happened in the history of the US markets, at least not going back as far as the data i've seen.
    #10     Aug 5, 2011