Spread Hedging Strategies

Discussion in 'Options' started by jones247, Jan 19, 2009.

  1. As opposed to the traditional Iron Condor, especially in these volatile times, I'm considering combining debit & credit spreads with a directional bias.

    For example, if you believe that a company's earnings will cause the stock to sky-rocket, or a commodity is at a unreasonably low point, then enter a bull call (debit) spread simultaneously with a bull put (credit) spread about a week before earnings or a few months out on the futures contract (assuming that the IV among the spreads is favorable).

    The good news is that if the trade goes in your favor, the credit spread helped to pay for the premium of the debit spread. The debit spread has a favorable risk/reward ratio.

    The bad news is that if the trade goes against you, the debit spread serves as an additonal & unnecessary cost. Also, the risk/reward on the credit spread is unfavorable. However, if the stock, index or commodity is at a really low point, it may be worth acquiring the underlying at such a low price (i.e. S&P below 750, or the RUT below 350, or oil below 35 for a April contract).

    It seems that the worse case scenario would be that you would get the underlying asset (particularly a commodity) at a bargain basement price. Unlike some stocks that plummet, most commodities won't go out of existence. For example, oil, gas, or soybeans can't go below 0.00. Also, the federal funds rate can't go above 100. Commodities provide an absolute bottom, with no where to go but up.

    Walt
     
  2. so what's your secondary exit?
     
  3. oh I see you get the stock.
     
  4. If I understand your position correctly, you could achieve the same result (pre expiration) by just buying the bullish call spread at the outer strikes, thereby avoiding all the extra slippage and commissions. Expiration is a different story since you have a no profit/loss zone b/t the inner strikes.

    Since your spread will probably have little or no cost, the worst case scenario is that if both sides were to be exercised, you'd lose the difference in strikes of either spread (assuming it's balanced).

    If you take delivery of the underlying via assignment and close the protective put leg for a profit, you'll own it for the new current price plus the aforementioned max loss. Doesn't seem like a great deal to me.

    It might be a good idea to post the components of the trade so anyone responding is on the same page as you.
     
  5. The Iron Condor is a delta/gamma neutral (or very close to neutral) non-directional strategy. The strategy you are considering is simply combining two equivalent directional strategies. If you have a directional outlook on the underlying, couldn't you accomplish the same thing by establishing a more cost effective strategy?

    Sorry if I am missing something!