Can you please let me know if they allocate funds in case the drop is not severe enough to make money on longs yet enough to loose (or take assignment) on short? Or do they roll down, which is just getting them longer as the market is falling? Basically, I would like to know what percentage of assets is acceptable to keep in cash for the purpose of hedging gone wrong.
I think there are a lot of variations possible. I also did a (very)quick and dirty backtest this morning, and arrived at the picture below for reference. Period 01-2015-09-2020, orange= long portfolio 'method', blue= +otm puts, grey = combined. This is a very back of the envelope analysis and needs far better testing. I used simple 6M puts, rolled every 3 months, around 8-10% otm. Keep in mind that you need to use strikemanagement for this. The first dip(2018) seems to be the most of interest, where it didn't worked out. But this is really a quick dirty test and is only the starting point of more analysis. I was wondering how you do your testing? I personally bought spy data from the CBOE and use Python(pandas/anaconda) and Excel for analysis. Option data before 2015 becomes more inaccurate, especially weeklies. Dips in 2018/2019/2020 do provide some good reference points though.
Usually they don't slap on a 4x1 backspread and go on vacation. The idea is to maximize gamma and volga and finance the bleed with just enough theta to be neutral. Positions could be over various tenors and options are traded on a daily basis
Aren't these long puts going to lose much of their time value as underlying goes up? How does it compare to buying risk reversals in this case?
Hey Z,sorry for the delayed responce.. I use Orats for backtesting and scanning...They are doing some really cool stuff.
Guru, I have spent more time than want to admit tinkering in PLs with lock or near lock trades. Hard in real world to get them to work though. Months later how is this working for you?
I rarely post my actual trades so I didn’t trade these specifically, but I do tinker/experiment with a lot of concepts to learn and figure out what I’m missing when I lose. Sometimes, and I suspect my 2nd trade idea posted in this thread, such trades can potentially be faulty in terms of interest rates, so missing even seemingly a minor issue can already throw off the P&L. It’s also difficult to keep the delta in check. But that trade shows more potential to make money if the stock moves substantially. Not sure what you mean by “lock trades” but I’m assuming locking-in the profit or locking onto small range of movement, which in both cases may simply mean keeping small delta. With many of my trades I have to take more risk, which then means I have to trade statistically and not based on greeks and trying to lock anything. On another hand, pro quants use gamma scalping (delta hedging) which somewhat does try to lock the profit and lock onto small range of stock movement and even limit it further by quickly harnessing any extra profit from small moves outside of locked range. Same with collecting theta where you also don’t want too much delta, thus profiting from locking the position, in a way. And again with hedging, you aren’t hedged if your delta is high. So out of all greeks, when I do use them then I may mainly pay attention to delta, and try to keep it fairly small, which may be a form of “locking”. Though some of that comes naturally and I know I have a small delta with some trades (not majority) that I do almost mechanically. Not sure whether this means “locking” but in a way on such select trades I try to profit from both lack of movement and/or outsized moves of the underlying. Though the risk always has to lay somewhere, and I have to question myself all the time whether it’s not all smoke and mirrors, which seems you’ve noticed as well.
Guru thanks for in depth answer. A lock trade is one that PL calc says will make money at any price at expiration. Have found them, but in reality the PL calculators prove to be wrong.
This is for long term portfolio, so no hurry a first test on my side achieved mediocre results. I found better results to just sell a ditm call x% below current price on a continuous basis. If it drops under your threshold percentage, stop selling until price of underlying reaches a new ath, otherwise you give back the profits from the downfall and it won’t work as a hedge. It would basically be an‘inverse PUTW’. You could test this( just try 10% for example), but it just consist of the following elements: -win on a drop > x% -lose delta on the upward drift -collect small premiums I didn’t take vega/theta/ delta into account(yet). And remember this is only just meant for a hedge of a simple long portfolio This is somewhat margin consuming, so you could turn it into a spread(including time or not) to reduce this. This has off course other pitfalls on its own.