I sold a bunch of strangles and am concerned that the volatility may surge. I want to use VIX to hedge against a sudden vol change. I found the vegas of my options are -0.01. With total 50 contracts, I figure the total vega is -0.01*100*50=-50. My options have high IV than SPX, let's say twice as much. If VIX rises 1 point, my position's IV would go 2 points higher. I would lose $100. If I sell deep ITM VIX puts at 40, for each point rise in vix, I would gain $100, nearly point for point. Would this effectively cancel out the volatility risk?
Selling a strangle is a volatility bet, so if you are concerned about being wrong to the point of needing a hedge then why did you trade it in the first place!?
Let's say that the strangle has a bearish bias that is I was after, betting on a decline, but not sure about the timing and afraid of the fluctuation in the mean time.
Well no. I assume you're short strangles in shares, not index. You are trading delta-one in the deep itm put. There is no extrinsic-value in the put, so you may as well buy VIX futures. The futures are trading at a large premium to cash, so you have basis risk, a lot of it, as well as correlation. Variance is priced cheap right now (VT midpoint) but the synthetic var is priced high. IOW, stay out of VIX options unless you're selling down and out puts, the strikes under 25.
You sold strangles first, then begin to concern the volatility surge ? Shouldn't it be the other way around ? You did not mention on which product you sold the strangles, sounds like it is not SPX, then how do you know the VIX will help. If you want to use VIX to hedge, remember that VIX itself is a dynamic beast, to borrow Michael Steinhardt's words, then you are going to deal with two problems instead of one.
After May 2006, Feb 2007, and Sept 2008 l have respect for people who essentially short volatility :eek:
I don't see a problem with the idea of using VIX options. He's short volatility, but wants to hedge his position against a major market move Only thing I don't understand is the selling of deep ITM puts. Why bother with another naked put position? If you're going to hedge against a rapid surge in vol, just buy OTM calls.
This and other posts involve some confusion between volatility and vega. But, whatever... If he really wants to buy vega, best bang-for-buck is buying tiny options. As to VIX options or futures - they'd just add another layer of complexity and headaches.
I agree with Rodney. VIX options are actually a horrible hedge against standard options positions because they track the futures not the actual VIX. If I were really trying to protect myself I would buy a much wider strangle on a ratio (maybe 1.5 to 1). http://www.option911.com