Some help required please...

Discussion in 'Options' started by Uncle Monte, Sep 26, 2009.

  1. Uncle Monte

    Uncle Monte Guest

    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%?

    I'm just looking for the most robust (and obviously cheapest) way of protecting myself against explosive moves.

    Any thoughts on this would be really appreciated.
     
  2. No expert here, but a couple of things you might want to think about, get a paper account and test out what your trying to do. The further away you get the bigger your spreads get, add on commissions and that could turn out to be some pretty expensive insurance...

    the exact number of contracts would depend on the delta of the option strikes. ATM would roughly be 2 options for every futures contract. Further out would mean more options to edge your positions. Pretty straight forward calculation though.

    the problem is with what you are trying to do though, if it shoots off one way, you wont really be covered.
    When you put on the strangle you will be delta neutral, once you put on the futures trade you will be uncovered again.

    In theory, you would want to just be covered to to down side of your futures trade.

    The easiest way is to grab a paper account and run your ideas. You will very quickly see how it works (or doesnt...)
     
  3. wayneL

    wayneL

    What you've got here is a synthetic 1.4650 call.

    Same thing as just trading the call itself, but costing yourself extra commish. Even trading the call only, it will cost you double the commision to get the same deltas, plus what you lose on the bid/ask.

    I agree with the other poster. It's expensive insurance for a daytrade.

    Too expensive IMO.