Question on hedging with options.

If I am hedging on a failed breakout, like say a wedge breakout closing in on its apex, where if the breakout fails it will in all probability fall back to the bottom, do I hedge with Puts on its potential price at the bottom, or do I hedge with current in the money Puts?

If I hedge with potential bottom Puts that are far out of the money then it will cost far less to hedge for a 10-20% failed breakout allowing me to use that cost to purchase more initial long shares for the breakout, but will render them worthless if it does breakout. If I buy in the money puts it will cost far more disallowing a greater purchase of long shares, but will allow me to sell them back at a decent average if it breaks out.

Not sure which would be the better strategy and would appreciate any feedback ty.

 

Hedging with options is a form of a stop-loss strategy. It's an art, not a science..... IOW, it's a guess.... hopefully an informed one, but a guess nonetheless.

Suggest determining "how much am I willing to lose if this play goes against me?", and place your option there.

Niggling with less is just minutiae. KISS, baby! As always.

 

Being an options buyer, I would favor buying in the money puts vs out of the money puts. You would have more residual value left of the put option assuming your hedged stock goes much higher. If it drops then, your chances of offsetting losses is greater as the put option increases in value. Since, you are going to sell that put to close it at some point, the greater the value left, the better.

 

That's a good point. One strategy leaves zero value while the other leaves some value. Ty.

 

You will also be under hedged buying OTM

 

Could you elaborate on that please? I'm not grasping what you mean.

 

I do not hedge break outs with puts, I use stop orders.
But if I did, I would use a Put with a delta equal to the probability of breakout failure.
Since in general most breakouts in stocks fail, I would go for ITM like smallfil suggested.

 

Sure
Using delta as an approximation of shares

Simplified example:

ATM option usually equates to 50 shares
ITM is greater than 50 shares ie. so 75 delta is equivalent to 75 shares
OTM like a 25 delta would only represent 25 shares

Your hedge is not really a full hedge... Your never going to make the amount your going to lose on the shares with 1 OTM put

Smallfil says the ITM is the better hedge because it represents more shares

 

Ya, my initial thoughts were that I could buy less OTM puts because they would equate to the X% hedge when they transitioned to ITM.

 

If you have ToS, look at the RR graph of hedged stock compared to the RR of an ATM call.
I'd suggest the call.