First off let me say I enjoy reading your journal and thank you for posting it. You have a great deal of experience and in your own mind what is "known" and "second nature" to you; it is not so obvious to others (me). You chose your edge by determining risk/reward and value. Do you do a graph of P/L, volatility, or just plain math? After you make your choice you trade within that position as you have written, just wondering how the process starts. When I put on a position I want to be hedged and no matter what the combination of stock and options it will be directional, although I will trade within that position it isn't as efficient as I would like. That's because I use charts/TA first and my questions to you are to maybe find a different starting point.
I determine the risk reward by just using math. Typically, the scenarios I will use will consist of a variety of price points at various places in time. The dates used for analysis include today, the expected holding date and expiration. The price points include best, worst, high probability and unchanged. I will analyse each price point in each time frame in both adjusted and unadjusted scenarios. For this trade, the expected holding time was a week, as the position is much smaller now this has held. The high probability move was up and down a point. This was achieved in the one week time frame. The other high probability points were 16 and 12.5. I assigned chances of these prices being reached more arbitrarily than using some sort of distribution model. In other words, I take where the stock has traded, the entire market has been and where I think both may be headed and assign my own probabilities. If I remember correctly, the entire risk of the position if held to expiration was on the order of $3500 unadjusted. Up and down a point, the P&L was to be $2000 on the upside and $1500 down. The profit target on the point move was achieved. I made two thousand dollars on the run up. It would be incorrect to say the risk/reward was 3500/2000. I never would have let go it to that point. The worst case was more like a risk of $850. The reason was that the prices the position was initiated with was, to pat myself on the back, awesome. The price on the 15 calls was too cheap. People had been selling calls to MMs for that whole day even as the market moved up. That action was very telling, I have seen it before where vol gets crushed nearer to the beginning of the move rather than the end.
When you say it will be directional, do you mean it always has directional risk no matter how well you try to hedge or that you hedge but want some sort of directional risk or anticipate some sort of move? Are you fustrated there isn't more P&L out of these moves which were anticipated?
The position right now isn't very well set up for earnings making some adjustments. Ran into margin limitations on Friday after buying 2000 shares after the close. I wanted more but couldn't. This morning I sold 40 of the 17c for .10, sold 10 of the 15c for .90 and bought ten of the 12c for 3.10 and sold 1000 shares at .61, also bought ten more of the 12c for 3.00, bidding right now for ten more. I want to buy back the 12s if they'll give me free money.
Sold a ten lot of the 15c for .95, wasn't a able to get filled on anything in a pullback, so bought them back for .95.
You didn't seem to be directional, but after your explanation you do, in fact, have an opinion about a stock. I have a directional bias(move) and was trying to be more discretionary about my selections. The 2nd 3rd trades after the initial position are what "makes" a trade, I believe, and thatâs what you do well and what I was asking to be explained. Trying to be more efficient and adjusting as I go.
Delta neutral can be a misnomer as a position can have different characteristics as it moves. In my position, while I said it is delta neutral when it was first put on, it was acutally leaned long by 1100. One reason was the bullish bias, but most important was where my long premium was situated within the position. The long gamma came from out of the money calls. To compensate for the likely hood of false deltas, I chose an appropriate level which still left me with plenty of profit to the downside. These deltas were factored into my risk/reward scenarios. If the position was truly delta neutral, it most likely would have been slightly more profitable to the downside than up. So, the first place to start with your hedge is to look at whether you will run into similar problems with your position. Another area people can run into problems with hedging is the comparision between the characteristics of the two. In other words, hedge an option with one that has similar traits. For instance, a poor hedge would be if, in IBM, you sold an Oct 75p, bought a May 95c and sold stock delta neutral. In this scenario, if the stock went down, you would be OK, if the stock went up, you'd be slaughtered. It is an extreme example, but it illustrates a point that the further away in strikes and expirations two options are, the worse the hedge each provides the other. Hedge an option with a like option. More Later....