Futures plus options - how to hedge

Discussion in 'Trading' started by misterkel, May 15, 2019 at 4:42 PM.

  1. I'm looking for advice on how to trade futures against options. Using Deribit.
    It seems like hedging options against futures or vice versa is not a strategy easily found, but I can't figure out why not. I don't trade eminis, but it seems that there might be viable strats trading them against SPX / SPY options.
    Any thoughts?
  2. drm7


    You need to have a view on the volatility of the underlying. If you think that future volatility of the underlying will be lower than the current implied volatility embedded in current options prices. , then you sell the (theoretically overpriced) option (ES/SPX/SPY) and hedge it by buying an amount of the underlying (i.e. ES future or SPX) sufficient to cover the current delta of your option position. As the positions move around on the journey toward expiration, you buy/sell the underlying to maintain the hedge (i.e "delta hedging").

    Switch everything around if you think volatility will increase relative to the current implied volatility.

    You can trade options against options if you think one is underpriced relative to the other, maintaining the delta hedge by adjusting the options positions. Make sure you understand the differences between the options contracts!

    If that sounds easy, it's not, because you need to have a differentiated view on volatility. Otherwise, a perfectly-hedged position will earn you the risk-free rate of return at expiration (in theory), minus transaction costs.

    Read the book "Trading Volatility" by Euan Sinclair for more details. It requires very low transaction costs and a lot of capital.
    bone likes this.
  3. bone

    bone ET Sponsor

    In terms of the major index names there will be precious little "meat left on the bone" for a speculator to cover his costs and make a profit day trading or arbitraging major index options versus futures spreads.

    It is a strategy heavily used by exchange cleared and OTC options market making groups. Everything from the mundane to the esoteric. As DRM7 mentioned in his post, the strategy is very capital intensive and the proprietary trading groups employing it use in some circumstances floor traders and the norm is a very expensive software platform like Orc Market Maker along with expensive [fast] ECNs. Firms like Jump and DRW spend enormous sums on ECN infrastructure. This is very straightforward and not particularly difficult as far as pricing model theory goes - but in terms of capital required and competition it is very much an adult swim. In fact, you need at least one exchange seat [depending on the name] just to make the math work in terms of execution costs.

    Since many of these names (not SPY necessarily but other less liquid options) can be illiquid at times - these groups are always carrying positions. Some of the greeks (like theta) can be accounted for and hedges adjusted accordingly over time - but gamma is another matter. It would be typical for these groups to buy or sell outright futures [that were not part of the original hedged options vs futures spread position] over the course of a trading day just to balance the gamma exposure on the portfolio of positions they are carrying.
    Last edited: May 15, 2019 at 5:38 PM
  4. LanceJ


    Long Hedging or Short hedging. I've been practicing Long Hedging, Buy index ETF Calls and sell index futures to lock in profit or to protect my intrinsic value. I struggle when the prices gap down or when prices continue down just far enough to activate my hedge, but prices rise & I lose on both.
    I've been thinking that I am purchasing too much intrinsic value, in an attempt to buy less premium. I end up selling futures at the bottom of the market for protection, but it just seems to protect me from getting profits.