Using options for hedging

Discussion in 'Options' started by Stoopidly, Nov 20, 2012.

  1. Hello all,

    I have a couple of questions I was hoping you guys could help me with. I have tried searching for it but I can't really seem to find specific answers to what I'm wondering about.
    I'm currently working on a strategy for stocks and got it working pretty well for the most part. Now I'm trying to optimize my profit ratio by hedging with protective options.

    Basically what I'm trying to figure out is what the total cost of a protective option is, and whether it is worthwhile to hedge with an option or not.

    Say I want to buy 100 CSCO stock at current price $18.20 and hedge it with a long put option for december 21 with a strike price of $18.00. The last traded price of that option is $0.42 so the maximum loss I'd see on that trade would have been $42?
    On the other hand a long call, with the same strike and date, is trading at $0.47, so a total loss here would be 0.47-0.20 = 0.27, or $27 (for the option only)?

    If this is the case, why would I want to buy stocks and a protective put when I could just buy a call ?

    If my average loss per trade is $43 (not including commissions to make it simple), would it be wise to just hedge with an option, and save myself $1 ?
    Or keep it simple and just buy a call ?

    I'm very new to options so I'm sorry if I have made some very obvious mistakes here.
     
  2. you just answered your own question... the downside to owning calls is you can't hold untill profitable.. the upside is that instead of having a lump sum tied up in stock and a protective put.. which is the synthetic equivalent for a call .. as you stated.. you can diversify with many more trades and of course stay alot more liquid to..
    there is alot more to buying premium then first glance.. your expressing a view on direction , and magnitude.. you'll llearn very quickly buying calls that you can be right about direction and still be losing money.. me personally buying deeper in the money calls that are "leaps" meaning they are years out.. is better then buying stock .. if the calls are fairly priced and liquid.

    option trading can be alot less risky then trading stock... keyword "can"
     
  3. sle

    sle

    You should mentally separate the usefulness of options for hedging and for leverage. If you own a portfolio of stocks that you like for whatever reason, you can buy an option to protect yourself against a correlated market event. E.g. if you like CSCO, AAPL and a few more tech stocks, you can go and buy a put on NDX to hedge yourself against a general decline of tech stocks. If you know (or think) that AMGN will have a favorable report coming up, you can get more bang per buck by buying a call option.

    Further, for an investor (not a trader, sic) a stock+put position is not perfectly equivalent to a long call position. If you think CSCO is going to go up and you want to take a leveraged position, you can buy a call. However, from a timing perspective you can also envision a situation where you own a stock as a long-term investment but expect some volatility in the short run, so you buy a put to momentarily cover your downside.
     
  4. Are you leveraged?
     
  5. i remember hearing that saying "the lie of leverage" although i don't agree when people say something like.. buying an call option is the equivalent to buying 100 shares of stock.. because .. just like a call isn't exactly equivalent to a married put. an out of the money call option with a delta of like .02 is only the equivalent of 2 shares of stock drifting towards 0 in time with all else being equal.. leverage has cost.. protection has cost.. and usually when protection is thought to be needed its already very expensive.

    next.. one i think one would ask SLE .. how do you figure out how many puts do you need to hedge yourself in the NDX considering your exposure in single name tech stocks.

    another thing i learned the hard way is.. buying options going into an event.. like earnings is a little more complicated.. when buying a call option at earnings your are expressing a view that earnings is going to move the stock more then the options already have priced in.

    another strategy to look into is the collar.. due to put call parity... if puts are expensive , calls will inherently be expensive as well.. there for if you think their will be a short term draw down in the stock.. you can collar it.. by selling a call for near what you pay for the put..
     
  6. Not necessarily. It's like stating you can put on a neutral collar in the SPX for even money.
     
  7. i said " by selling a call for "near" what you pay for the put.." negative skew on the spx .. get correct boiiiiiiiiiii
     
  8. Like stating I nearly won the lottery. There is no P/C parity relationship to symmetrical otm strikes. wtf are you blabbering about with the -skew comment?
     

  9. umm.. idk... i was thinking at least that if puts are expensive then calls would have to be similarly expensive..... then a collar would be at least a cost mitigation to buying expensive puts in a case where risk premium has went up on an anticipated event.. the put call parity comment was thoughtless.. your all strong with your "wtf" wtf.. ? i must sound like i'm getting ahead of myself with the things i say..
     
  10. i kinda of thought that .. if puts were over priced related to calls.. you could sell the put , buy the call and go long the stock in a reversal for a profit.. creating an arb opportunity then equalizing and causing the calls to be come more expensive and puts to be less after many arbs ... doesn't that have something to do with put/call parity?
     
    #10     Nov 20, 2012