Levering up hedged portfolio to reduce insurance drag

Discussion in 'Options' started by Tomaz26, Mar 3, 2018.

  1. Tomaz26



    what do you think about levering up options hedged portfolio, to reduce a drag that buying put options have on such portfolio. Lets for example say that the only thing you have in a portfolio is SPY ETF (or sp500 futures etc..). You hedge it with puts (or put spreads to reduce cost). Because such "portfolio" is much less volatile, can you enhance returns by levering it up? I could do it cheap via IB and can lever up for example to 130 %, or 150 % or.. I think a chances to blow up such portfolio are small (low leverage and hedging with put options) because of small draw-downs. I think someone posted in other thread buy write SP500 index performance and volatility was half of what sp500 has and draw-downs were much smaller.

    I am probably missing something that is why I am asking. Thanks for pointing it out :)
  2. alexpun


    What if the market drop just above the strike of your put option?
    You can try to draw a payout diagram to see where is the weakness of this strategy.
  3. Assuming by levering up, you mean deeper OTM puts, this is the strategy Taleb used to make a killing off of 1987.
  4. Tomaz26


    I was thinking more in the lines of buying underlaying on margin. Or using futures.. For example if you have 100.000 EUR portfolio, buy 130.000 EUR worth of SP500 with SPY (on margin) or futures (apply slight leverage) and at the same time hedging with puts. Either deep OTM and lots of them etc.. Did not think about the actual strategy for options yet, but only about reducing volatility with put options and because such portfolio would have greatly reduced drawdowns, one could apply leverage on it.. Not big one, but 1.2 to 1.5 or something like that..
  5. spindr0


    Underlying plus long put is synthetically equivalent to long call (similar results) so if placing the two legs simultaneously, buy the call.

    On an expiration basis, the risk of (U+P) is the distance to strike plus the cost of the puts. There is no chance of blowing up because most of the downside is managed.

    If you buy more puts than underlying, you increase your exposure to time decay and if the underlying languises, it eats you alive, slowly. Prior to expiration, IV change may help or hinder you as time premium expands or contracts. If you use margin to increase position size, you increase the time decay exposure.

    A straddle has a V shaped risk graph with each side appreciating at a 45 degree angle from the strike. With levered puts against underlying, you also have a V risk graph with the apex at the put strike and the angle of ascent on each size depends on the ratio. Model it and you'll get a feel for performance before and at expiration.

    Here's some of my reality that modestly resembles your question. I went bottom feeding this week on a $78 stock (one year low). I legged into something resembling a combination of put covered stock (monthly options) and a bullish diagonal put spread (weeklys) for a net exposure of 1,000 shares. As it dropped, I rolled the long puts down, pulling gains out (not profits since the other side was losing).

    With each roll down I bought a few more puts in order to maintain some net long put delta. On the way to under $75. I rolled multiple times. Yesterday, I sold some OTM weekly calls against this mess in order to catch some add'l premium flow. I may come to regret that because my initial intention was to be long the stock. I kept some unencumbered long shares to prevent locking in an upside loss should it pop. The end result is that I have offset all of the $1,400 drop on the equity side. I could walk away from this at a break even, making only my broker happy for my efforts :->)

    The point? If the stock collapses next week, the extra puts net me more than the stock loses. I'll just keep rolling them and the short calls down. If the stock pops nicely, I'll make something but nowhere near what I would have if it had risen from the get go. At least I didn't take the hit from being the deer in the deadlights, watching it drop 3+ points. Sounds good, eh? Unfortunately, no man's land is in the middle and if it languishes, my 1.5x OTM put levering is going to take some money from me. There's always a price area (dead zone) where this bites you.

    Where we differ greatly is that I'm chasing singles and you're chasing home runs. Either way, know where the dead zone is before you place your bet.
    Tomaz26 likes this.
  6. Tomaz26



    I like your approach. I almost did something similar with CL options after the big drop two weeks ago. I had 74/51 strangle which I opened at the time when CL was at 63. It then went to 65 before colapsing to 58.. Puts I sold for 0.05 were at the peak worth 0.35.. Talk about 700 % increase :)) It took my account down quite a lot, but I did not panic. The price was still far from my 51 put, on the way down I closed 74 call and sold more 72 calls which when CL was 60 and on the way down to 58.. What I had ready was if another leg down was coming I was prepared to buy back 51 put for 0.50 or something like that and sell 1.5x as much 46 calls.. This would buy me more leeway until expiration (which was less than a month at that time) and I kinda knew that bounce will come sooner or later. I did not expect CL to drop from 65 to 46 in 5 weeks, although not impossible for sure. But I could still spread it out in time or even lower to 41.. I had more than enough capital ready because used margin was 10 %... But this is also playing with fire.. :) But unless one is too leveraged or using too much margin, you can repair iron condors or strangles many ways and specially with instruments like crude oil which kinda trends and not gaps so much, it is quite ok.. It would survive even some of the most drastic oil price shocks, specially if you deal with options that are a month or less until expiration.

    Well at the end I did not need to do anything because oil bounced from 58 nicely and was soon back to 63 so I closed the whole thing for a slight gain. I could wait until expiration, but after those puts increase 700 % I decided I need another strategy.. Or at least stay away from selling strangles or IC when IV is low. If I waited for a drop (which was almost inevitable) on CL, I could sell those 51 puts for 0.35 and close them a few days later for 0.05, instead of selling them for 0.05 and watching them go to 0.35 and almost having a heart attack :)))))