Managing Deltas / Hedging Frequency

Discussion in 'Options' started by Magic, Nov 2, 2018.

  1. Magic

    Magic

    Hey guys, do you have advice on how I should be approaching risk management for vega & gamma?

    At times I have various positions on of different options and hard deltas. And I have my global SPX delta band that I want to stay in. It's attractive at times to sell more options to hedge instead of using hard deltas. If/when things calm down the PnL is better than using the underlying. Unrealized losses from vega eventually have to bleed off by expiration anyway, or rather everything is converted into delta PnL eventually.. however you want to say it.

    But obviously if you go too far the vega/gamma position can blow up in your face. I've been using options in small enough size and close enough to ATM that unrealized vega losses even in a rise like this last one haven't made a significant impact.

    I'm left wondering how to keep an eye on global vega/gamma from getting too dangerous. Are there any short-hand risk metrics you guys use? Like ratio of theta:delta or theta:risk budget? Ratio of vega:delta? Even when I shock my vegas -10% or something the losses are still dwarfed by the estimated delta losses from the same scenario. Left feeling like I can be a little more aggressive on sizing when it's +EV to do so, but not sure how to gauge the risk yet.
     
    #21     May 9, 2019
  2. ironchef

    ironchef

    What is a hysteresis band may I ask?
     
    #22     May 10, 2019
  3. srinir

    srinir

    It is exactly what he wrote.

    For eg. Suppose you have delta neutral strategy and plan to hedge delta certain intervals. Your trading plan allows to delta drift + or - 100 deltas. If the delta's have gone above the pre-set band of delta, then hedge back to that band of +or- 100 delta at the set interval and if it is within + or - 100 deltas do not hedge. As he says do not hedge all the way back to zero delta just to that pre-set delta band.
     
    #23     May 11, 2019
  4. Magic

    Magic

    Establishing a delta band is pretty straight forward. Still thinking on how to cap vega risk.

    If we have 100 SPX deltas, a 5% drop is just under $15K of risk. Depending the DTE on our options the IV on could possibly do +10% for shorter dated in the same situation if it happened fast?

    So -1500 vegas would produce the same risk. Around 15 Vegas is the same risk of 1 SPX delta.

    Still working on how to conceptualize and get a feel for risk posed by short gamma and how to apply it to shock tests.
     
    #24     May 11, 2019
  5. ironchef

    ironchef

    OK thanks.
     
    #25     May 13, 2019
  6. Parra

    Parra

    I think it's not that simple, volatility depends on how long the option expires, and whether the option is OTM or ITM, affecting what's called a volatility smile, so it's not an exact mathematical ratio. We know that changes in volatility will be more explosive in ITM options than in OTM options, thus varying the total price of the option depending on what position is.
    There are theories that to be able to compensate the risk of negative Vega in the operations with options, is that theta is approximately between 20% to 25% of the negative Vega. This is based on the fact that statistically the market is 80% of the time in laterality and 20% of the time in trend. You will not be able to maintain this ratio if you are many days away from expiration, recommending that this ratio can be fulfilled from 30 days to expiration.
    Although you can partly cover the risk of Vega, with Theta, you are going to have another more important risk from 30 days to expiation, which is the gamma (the hidden risk in the options). I never have operations with options less than 21 DTE, the gamma can destroy you, it does not compensate the risk-benefit, but that could be another debate.
     
    #26     May 14, 2019
    Magic likes this.
  7. raf_bcn

    raf_bcn

    Hi @Magic

    I have almost no experience in hedging and mantaining a position delta neutral. But now I have a position that I don't remember why I initiated it, and that will need to be hedged.
    So I have thought a little about the possibilities.

    Your questions seem very interesting to me. Yes it seems attractive to sell options to hedge a position instead of hard deltas - underlying , futures or synthetic.
    But an increase in iv will make the position difficult to manage, mainly because of the increase in margin requirements from the broker. That is the principal risk.
    Maybe the solution is to be able to take the position to the expiration.

    One experimented trader told me that is not a good idea to have more than a 10 % thetas of your total net liquidation value. Maybe that is an important risk metric.


    Hi @Parra
    When there is a change in iv, the value of atm options will change the most. They have more extrinsic value than itm or otm options
     
    #27     May 14, 2019
    Magic likes this.
  8. Magic

    Magic

    Hi guys, great discussion! Re: Parra, so far it feels more stable to be short vega for systemic collection of risk premium vs. short gamma. If gamma was where the real juice is, we should be shorting short-term ATM's and doing the work to hedge risk. But it doesn't feel like we get paid enough to go through the trouble vs. holding longer DTE and profiting from IV bleeding away which is the normal case. I'll tolerate short gamma in smaller size but try to isolate short vega as best I can.

    Re: raf, I think we are considering the same concept. When faced with the need to hedge it seems advantageous to a degree to use options, and we collect premium but if done right the risk doesn't amplify.. they offset each other. But do it in too big size and you other risk from vol spike or gamma risk will eventually exceed risk limits.

    Practical short-hand measures on how to know what size to remain at in order to be able to take position to expiry and not be forced out unexpectedly is what I am trying to develop. Perhaps theta as % of net liq is the best metric. I'm assuming you meant 1%? I was at 0.5% when I started to question the risk I was holding but still felt like I had some room left so that seems like it fits pretty good.
     
    #28     May 14, 2019
  9. raf_bcn

    raf_bcn

    Yes , oops, sorry, I mean 1 % . But in fact I really almost never reach this limit.
     
    #29     May 14, 2019
  10. TheBigShort

    TheBigShort

    Hi magic, have you thought about hedging with other risks? For example, if you think vega is expensive, can you buy "cheap" gamma some where?

    Also Systematically short vega to collect the risk premium is most definitely not the best way to treat your capital. IMO its best to short vega (greater than 1 month options) when you have a directional view on Implied Vol. Otherwise, stay away.
     
    #30     May 15, 2019
    srinir and Magic like this.