Using options for hedging purposes

Discussion in 'Options' started by Tomaz26, Aug 28, 2011.

  1. Tomaz26



    I want to start using options to hedge my mostly stock portfolio positions. Is it a good way or too expensive? I know now that volatility has risen it became expensive but how about buying hedge after a long up-run? I do not wish to speculate when drop will come so selling my portfolio is not an option. I just want some insurance which I could sell if the price drops and just and re-buy it later if prices rise again etc.. I can see that after low vix values there are allways times when VIX shoots up and then again fell down etc. So how about strategy with buying insurance when vix is low and then selling it when vix is high. I know it could happen that VIX stays down for a long time but since I am long stocks at that time I would just loose some % of my portfolio on hedging on the other hand when prices drop 15-30 % I could lower my drop in portfolio with put options.

    Now the question is how much time should I buy for hedging purposes and which strikes? Should I buy ATM, ITM, OTM, 3 month, 9 month ... I know last 30-60 days options are expensive beause of time decay so I guess those are not good for portfolio hedging.. Also how much should you risk for hedge? If hedge lowers your portfolio value by 3 % yearly this could be a problem.

    Does anyone here use options for hedging purposes? Can you please explain how you choose strike prices and how much time you buy?

    thans to all for help

  3. not to be the bearer of bad news so early but if you're not willing to spend 3% protecting your port from catastrophic decline then just take the risk. see recs from above poster re collaring. insuring anything costs money, period. there is no way around it.
  4. Tomaz26


    Thanks for suggestions. I found a very good paper testing different collars for QQQ from 1999 to 2010 with very good results. This strategy of course trails returns in bull market(returning 5-7 % yearly instead of 21 %) but really shines in nasdaq decline in 2000 and also very good returns from 2007-2010 ! For example in declining years you get +23 %. I must read the paper again in details because I am not sure how you can get so drasticaly better return in declining years. I though with collar you cannot earn much but you also cannot loose much. I think the strategy was buying 6 month puts and monthly selling 1 month out calls. All in all you get more than 1/2 lower volatility with nice yearly returns. I think now after such spectacular run-up in 2 years it is time for this strategy. I guess the only time not to hedge like that is after 50+ % sell-offs after recessions etc.

  6. Is there a fundamental benefit to heding an option position vs. closing out the option, assuming the hedged position will remain intact through expiration?

    any thoughts...


  7. convexity

  8. thanks for the reply...

    ...but I would imagine that if the hedged position is being held to expiration, then only pin risk would be of concern. However, I don't see why convexity/gamma would matter if I'm holding both the long & short option 'til expiration.
  9. Think I misunderstood you. Same option?

  10. A same month collar is equiv to a vertical spread. Using different months makes it a diagonal. Either way, you're not going to make +23% in a down market with long stock/index collars unless there's one or more of the following: legging in, ratioing, adjusting, and getting a favorable bounce.

    Somewhere I ran across an article about dealing with crashing collars. Their suggestion was to book the put gain at expiration, buy more shares with those proceeds and do a correspondingly larger number of new collars at the lower stock price. It's a losing proposition until the stock eventually rallies and then you cash out when assigned at the short call strike with a net profit. Essentially you're dollar cost averaging with your own money (the put gain) and eventually taking the last spread's maximum gain. If the UL never bounces, you're dead meat :)
    #10     Aug 29, 2011