OP (note the length): Firstly let me say I'm a futures trader so my knowledge of options is fairly basic. Hence, I have come to you wise people for your opinions. As a conscientious and risk adverse futures day trader (if that's not a complete contradiction in terms) I am always concerned with the possibility of liquidity suddenly drying up and price racing away, leaving me unable to get out of a position. I know that given enough time this possibility will become a certainty...it's just a matter of when... My trading methodology allows me to know very quickly when I've made a bad entry and hence I can trade with very tight entry stops (typically 4-6 ticks). However, given the danger of overleveraging, I only ever put on an absolute maximum of 1% of my trading capital at any time. This reduces the risk of a runaway 50+ tick move completely cleaning out my account. I also make sure I am flat going into any big scheduled news announcements (interest rate decisions etc). I've started thinking recently that I should be employing options to properly hedge my exposure. Initially I looked at maintaining a hedging options position at the nearest OTM strike to my futures entry price. E.g. If buying 15 lots at 1.4691 in the futures market, then hedge the position by buying 15 puts at the nearest OTM strike (1.4650). If closing the futures position then close the hedging options position. However, having done some rough calculations I quickly realised that, everything else aside, just paying the options commissions and spread every time would kill me... So I started thinking instead about setting up a full bi-directional hedge at the beginning of each trading day and keeping it in place until the close of the trading day. This would save on commissions and spread. The obvious hedging position is a long strangle. I'd adjust the strangle during the course of the day to keep both the calls and puts OTM. In maintaining the strangle the gains from selling the options which have drifted ITM should offset the losses incurred by selling the opposing options which have drifted further OTM. Considering the Greeks: Theta: Since I'm only holding the position for the duration of the trading day then time decay shouldn't really hit me too hard in the pocket. Vega: Given that this hedging position will really only come into play in the event of explosive volatility in the underlying futures market, this should work in my favour, pushing up the value of both the call and put options. Delta/Gamma: This is where I start to come a bit unstuck and my understanding of options lets me down. I believe that ATM options tend to have deltas of ~50, so in order to fully hedge my maximum futures position of 1% should I be taking a options position equal to 2%? As I said, I'm not an options trader so please don't hammer me into the floor if I've got something fundamentally wrong. I'm just looking for the most robust (and obviously cheapest) way of protecting myself against explosive moves in the underlying. Any thoughts on this would be really appreciated. Anyone else considering responding to this poster, ensure you do all your due diligence, before you have the nerve and try to actually HELP him/her. Prepare a 400 word written essay, detailing exactly HOW your advice can help a freeloader with an attitude problem. Make sure all your thoughts are well-defended. Meanwhile, no good deed does unpunished, so I am putting this one on ignore. This is the kind of person that have driven away successful traders from ET. I ignore a lot of stuff, but now I know why some leave.
I have been nothing but polite to you TraderZones, despite your propensity for juvenile melodramatics and large bold type. I intentionally wrote a detailed OP so as to be clear in my question and not waste anyone's time. If you couldn't be bothered to read it then you shouldn't have bothered replying. Please feel free to leave ET whenever you see fit. I'm am sure your sage like wisdom will be sorely missed...
One solution would be to keep only a minimum amount in your futures account. Put the rest somewhere else. For money management you could look at percentages of your liquid net worth and not of your futures account only.
Buy long dated ATM straddles and sleep better at night. You could also consider selling the Iron Condor to protect yourself. This allows you to hold your futures positions overnight risk free.
Scooby, I doubt Im adding anything new here, but anyway, the further out of the money you go the bigger you will find the BA spread. You may think you are trading the most liquid contracts but OTM options can be a whole different story, you could end up spending a lot of time and effort on making sure you get good entries and exits on your 'insurance'. The added cost in spread and commisions could easily remove any advantage to using this strategy. One possible solution could be to buy a long term strangle and hold it rather than entering and exiting multiple times. But dont take my word for it. Fire up a paper trading account and test them out. You'll find your answer a lot quicker that way..... Good luck.
Thanks everyone for your thoughts. Have done some additional calculations and, as has been pointed out by quite a few people, putting on the options insurance and then taking it off again each night would incur some fairly hefty costs in the form of the spread and comms. Certainly looks like the best approach is to put on the protective hedging position (be that a straddle, strangle, iron condor...etc) and maintain it over a period of days/weeks. Apart from cutting down on transaction costs this would also possibly allow me to trade the overnight market in some of the really liquid futures contracts. I'm thinking that I would manage the hedging position to keep it in line with price moves in the underlying, and that this would provide a hedged 'price zone' where I can operate my futures scalping strategy. I wonder if anyone else out there has tried doing something similar to this? There must be other futures scalpers out there who aren't comfortable with running naked directional positions.
I think you have answered your own question here. You are looking for disaster insurance, looking at a monthly chart of the pound I can see why. I would say buy some puts x sigmas out. I think that volatility usually tends to be expansive to the downside with melt ups being more rare. Interesting that the pair is quoted in pounds like the euro instead of USD. The problem with a straddle is you are paying for theta twice, very painful and expensive when the market is sitting still. You could try its ugly cousin the strangle. Anyway you may find this helpful on scalping. Gamma rent here to me is the same as theta, maybe I am wrong about this. http://www.cmegroup.com/education/interactive/webinars-archived/gamma-scalping-with-fx-options.html