Position hedging

Discussion in 'Risk Management' started by ecasene, Jan 10, 2010.

  1. ecasene


    Can you find the flaw in this belief

    I take a long equity position hedged with an ATM put, both positions have the same exposure to price although opposite but the option cost a lot less.

    In the long term the savings I make protecting wrong equity trades will offset losses I would otherwise have made even if I was trying to cut losses quick

    To save even more money I could hedge with fairly wide bear put spreads.?
  2. H2O


    I'm not an options guru (In fact I think my knowledge barely scratches the surface), but as far as I know an ATM option will usually have a delta (= exposure to price) of 0.5, meaning you would need to open double the position-size in options than your original (underlying) position. This of course increases your exposure to theta (time value), which will cause you to lose money even if the price of the underlying does not change..
    Of course I haven't even started on gamma here (your delta will change as the price of the underlying changes)

    I suggest you read up a bit on options before committing money to your ideas...
  3. What a thick surface you have scratched! :)
  4. ecasene


    Oh yeah of course . but I guess same question with two options
    Will two ATM options still cost less to put on than the equivalent short in the underlying? If the premium is small enough is it a smaller loss if the trade goes against you than if you had no puts at all?

    If the trade moves against me I chose wrong and will cut the losses so dont really care about gamma I don't want to hold a loser that long

    For sure

  5. piezoe


    Perhaps you should look into what is sometimes called hedging via married puts. This is a strategy best suited to volatile stocks, i.e., stocks that move a good deal both up and down.

    Though there are nuances and variations, the basic strategy involves buying atm or just otm puts to lock in profits as a stock rises to the next higher strike, and in-turn selling the puts bought as insurance if the stock drops in price. Any money made by selling long puts is used to buy more stock. The stock is kept continuously insured with long puts whether it moves up or down in price. Thus on the way down one accumulates more stock by selling puts at a profit, and on the way up one locks in accumulated profits on the stock by buying puts at successively higher strike prices. Of course, in either direction, profits are reduced by the cost of the puts.

    This strategy has its faults, the same as any other, but can be successful for certain well chosen, volatile stocks in suitable market conditions. It's a strategy only suited to stocks that one expects to hold for a long time through several up and down cycles.
  6. ecasene


    Excellent! Can you recomend a broker? I want to start soon as I can.
    Do you think I could pull this off with married Put ladders instead?
  7. piezoe


    I don't now what you mean by a "married put ladder". Any broker that you can buy options through will work, but it is important to get the lowest commission possible. Lightspeed maybe? That's not my broker, but they have very low commissions. Be aware that there is no "foolproof" strategy.
    You must choose a stock that is both very liquid and has a high beta, something about 1.5 or above, if you want this strategy to work out well..
  8. piezoe


    i should add that i only summarized the married put strategy. You should research it in detail before attempting to put it into practice.
  9. ecasene


    Thanks for the tips especially the ATM delta that was an embarrassing greeks 101
  10. For all intents and purposes, there is no difference between buying stock and hedging it with a long Put, and simply buying a Call. The risk and reward profiles of each position are equivalent. Might as well buy a call and save your money on the stock. Of course, if you've spotted a mispricing in the put such that the dividend of a stock in not included in the put's premium, you could buy stock, hedge it with a put, and collect the dividend for a risk-free profit (unless the dividend is cut). Those plays do show up and are even published by companies like Dividendium, but other than tactics like that, married Puts and outright Calls are essentially the same thing, just as naked puts and covered calls are equivalent.
    #10     Jan 19, 2010