Yeah, great idea - so your delta will decrease (because of the short gamma) as the underlying sells off which is when you need short delta the most Something does not agree between the two bolded statements, I think
. I am all about premium. That is where the bulk of my returns come from. If the IVR isn't rock bottom I will always be using short options to balance my portfolio beta-weighted delta's and adjusting positions as needed. For the short calls, I roll them when about half of the premium is sucked out to boost my negative delta's back up again and collect more premium. It is true that I lose negative delta's as price drops(gamma effect, as you mentioned), but if it goes sideways or rises less than the expected I will still profit. There obviously are trade offs between short stock vs. short options, mainly static deltas and no prem. vs dynamic delta's and prem. , but I will always go with short options if the IV is high enough and then actively manage the position as needed. Other options (no pun intended) could be to do a hybrid static and dynamic, change the expiry, ladder more calls at different delta's, or all of the above. Good catch. I wish the edit option didn't disapear so quickly. In any case, I find myself doing both synthetic short and long positions from time to time, or even a split-strike synthetic stock position, which I am a big fan of when candlestick/pattern trading. I am sure I will get to that down the road.
This is a bit of a long post but I had to lay some ground work. I think this is a great point to bring up because I would argue that in the long term, using short calls as a negative delta adjuster will beat out short stock or short futures(static delta) as the better approach, as long as the IVR is high enough (and it usually is after a large selloff). Why would I think that? First, I will take the position that nobody knows anything. We can all prognosticate about future market movements but we don't know. From that starting point, then we have to look at the fact that we are building strategies for the long term game where there are many outcomes besides just a continued drop in price. You mention a continued selloff, but anywhere from a sideways consolidation all the way up to a face-melter rally are also possibilities. I like to keep my portfolio delta's negative most of the time as downside protection from the unexpected plunge. If we get the plunge and my delta's shoot way up, say from -100 to 100. I can either put on static delta's by simply selling 100-200 shares of SPY, or I can put on a couple short calls and try to get somewhere in that same range. Let's say I am going with 45 DTE options, if the market goes sideways for the next month I will have both protected my portfolio with the extra negative delta's and the hedge will have yielded 1-2% portfolio profit. Pretty nice. It's the hedge that keeps on giving. In a different scenario, if the markets were to have a face melter rally, depending on my strikes and some other factors, I will likely take a small loss at first but if price stays within my strike I will still make full 1-2% profit. If the rally keeps going I will roll my call up and out to reduce delta and gamma risk on the position. With the static delta's, if the market goes sideways then the portfolio protection was there but it yielded me no profit, and likely cost me something to hold the short position. In a different scenario, if the markets have a face melter rally then this hedge is really going to hurt me. We will use a recent, real-life example. When the QQQ's decided to rally 4.5% on Friday, my 42 DTE call incurred a loss of 0.9% of my total account size. If I would have had static delta's then my hedge loss would have been closer to 3-4% of my total account size, ouch. That call option I had sold originally had 1% of profit in extrinsic value, and it now has 2%. As long as price stays below 161 by expiry, I will still make full profit on it. The 1% loss will eventually swing to a 1% gain. A static hedge on the other hand would sit and hold the full loss, incrue cost to hold, and pose serious upside risk of the stock market were to keep rallying. If the hedge is taken off then I lock in that 3-4% loss, not cool. That means the only way a static delta hedge comes out ahead of dynamic is if there is another large drop. Even in the case of a drop, a static hedge doesn't necessarily win. If the market drops and then recovers or does a side-ways downwards drift, or even if it drops but it takes a few months, the option will likely come out ahead. Even if there is a follow up plunge, the short call is not impotent, if it is actively rolled down it will still do a decent job hedging losses, just not as good as static short delta's. The question then is this, are there enough epic plunge's to justify static delta's over dynamic. I think looking at the history of plunges, the short prem. is the best approach. Many plunges would have actually netted a profit due to how much IV overstated RV. Also many of the plunges were followed by mega rallies (like the one that happened Dec 26 and the one that happened last Friday), any static delta hedge's would have accrued huge losses, and likely more than you would be able to justify for that once in a great while mega plunge, like in 08'. I know this can be a touchy subject but I have looked at a lot of studies and lived enough of these to feel that short prem wins in the long-term game.
Call me stupid, but I don't understand how you could lose less on a short-gamma position then on a delta one position, if you had the same initial delta (let's say your delta was flat on Thursday night). Edit: Nothing against the idea of having a negative delta lean though I'd argue that it's hard to protect a short gamma position via delta lean (e.g. it would be a more viable model if you where selling Jun or even better Dec). More important, however, is that by expressing that lean via additional short options you are creating a martingale. I.e. you are adding to a position (short gamma) that already went against you and while it will work most of the time, the time when it does not will be very painful.
I wouldn't call it a martingale, but I understand what you are saying, basically there is gamma risk. Again in that rare case it does rally beyond my breakeven, I roll up and out. I can do that until price pulls back or goes sideways and then let positive theta do its work. I agreed in my last post, and still do, that in the 1 scenario where the markets continue to drop rapidly it will hurt more. Until I see some research to show me otherwise, I think in the long game over many crashes, short options hedges will do a better job. That has been especially true over the past decade.
Keep the trades small, don't be a hero, and keep the delta and gamma down. Or the alternative, become someone who surfs other peoples threads making sarcastic remarks about it.
Let's just get this established off the bat. For everyone who drifts through this thread, if you don't have something constructive to add or a question to ask then don't post. If you are really bothered by what I write on this thread, then feel free to not read it. Sarcasm and snarky comments don't add anything valuable to the conversation and are frankly poisonous to threads. Thanks.