short strangle hedged with futures

Discussion in 'Options' started by Carl J, Dec 13, 2008.

  1. Carl J

    Carl J

    write a ndx strangle one or two weeks from exp.
    if the index stays in a narrow range no action needed
    if the index runs hard in either direction hedge the losing leg with the correct number of nq mini's
    at exp. if the losing leg is properly hedged you will have a wash on that leg and the other will expire worthless collecting the entire premium
    the tricky part is when to put the hedge on and when to take it off.
    any merit to this strategy or is it full of holes?
  2. I think last person to have naked short strangle positions was Nick Lesson. You will pick the pennies when things move slowly, but when the volatility sets in you may wipe out before you can close the positions. Have you considered doing an iron condor and adjusting it backwards ? Left options trading some time ago but a SHORT STRADLE is essentially a LONG IRON CONDOR but without wings, yes SHORT STRADLE would be more profitable but is it worth the risk to your account and mental health ???? Remember there is no BAILOUT scheme for private TRADERS here in UK or in USA !

    P.S. Correct me if l am wrong, do not lynch me, we are all adults on this board....
  3. Carl, I admit I don't know alot about the details of futures trading (I only trade options), but it seems like you run the standard risks that happen when you aren't hedged to begin with. That is that as a position moves against you, you need to decide when to hedge, and how much of a hedge you need, etc. Also, what if there is a huge gap one day or a super fast move that catches you offguard? Or what if the market starts to move strongly in one direction, but you think it will reverse so you don't place the hedge, and then the market really moves in that direction.

    I think it is always a tradeoff between having a hedge right from the start and not making as much money, or trying to make a bit more and adding the hedge later if necessary. I generally trade with the first type, but others might very well trade the later.

  4. The bottom line is you’re just talking about selling some premium which has a net result of negative gamma and then you’re choosing to hedge the negative gamma with the underlying. Its no different then all the other short premium strategies.

    The problem is the negative gamma. What are you going to do if the NDX is up big two days in a row and then craters for 3 days then is up huge a day then sits around 2 days? I am just painting the whipsaw scenario for you. Did you hedge with long futures on those first two days? If so how much did you lose on those futures when the NDX tanked those next three days? Did you get short futures on the way down? How much more did you lose in futures hedges when the market popped back up? That’s the whipsaw game with any negative gamma position.

    Of course you end up being nothing more then a directional speculator whose taken in a little premium selling some options and in return for that premium you giving the market the right to force your hand in the size of your “hedge” or directional speculation.

    If you must be a premium seller consider an IC as someone already mentioned.

    I am not saying it cant be done and there is a discipline to managing a negative gamma position but it does take expereince and huge amounts of discipline
  5. Carl J

    Carl J

    Jacks, you make some good points. The number of NQ mini's to use could be calculated with a little's when to put the hedge on and take it off that makes it tough. You would have to monitor this trade by the hour as not to get caught with a big move. Trading in and out of the mini's would cut into your profit but the premiums on ndx are large enough that you would still have a good gain
  6. This is always the magic to the hedge. If you were skilled enough to know when to put it on and when to take it off then you would make more money trading NQ outright given your ability to predict directional moves.
  7. Simple delta calculations will tell you how many futures you need to achieve the delta you wish, no big deal.

    The premium is yours once you sell the strangle. You’ll lose money in the hedges so there is no way for you to conclude that he’d have a “good gain”
  8. Sure, plenty of merit. Hedge fully (100%, not delta of aprox 50%) at either strike, unhedge back inside of strike by some hysteresis band. If two week forward realized vol turns out greater than impled when you put on the straddle, you should make money, provided the hysteresis band is wider than the slight negative AR(1) tick evolution process.

    This is a pretty widely known result, but I first saw it written up in a paper by Mark Rubinstein (writing under a pseudonym) "A Case of Confused Identity." Unfortnately I can't find a copy of the paper online or I would link it. A proof of BS hedge equivalence can be found in an appendix to the Carr, Jarrow, Myneni paper "Alternative Characterizations of American Puts." I have that one if you want it.
  9. Correction: "greater than" in the sentence above should be "less than."
  10. nhorob


    I've had this thought before and it seems like a very valid, simple strategy. The problem is how you manage your hedge. One one of the previous posters 'hit the nail' on the head by mentioning the difficulty in managing your hedge in a whipsaw market.

    Let's say you decide to implement your NDX hedge at 1100 by shorting X number of futures. What do you do if the market closes at 1075, 1130, 1095, 1125, 1060 five days in a row. If you are hedged completely at 1100, the hedge will likely make your entire possition far under water when the market trades to 1130. Much more difficult to mangage in practic. Just a thought....
    #10     Dec 14, 2008