It may be better to use a futures contract to hedge against an equity position. Instead of buying a put to protect your equity position, shorting the e-mini or SSF may be a better bet. With the futures contract there's no need to worry about Vega & Theta risk. Unfortuneately, you'd lose the benefit of gamma. I've been using a variation of gamma scalping with a synthetic straddle (long stock + long put), except that I don't necessarily try to remain delta neutral, as I go for much larger share sizes when I trade. In effect I'm really trading around a core option position more so than the classic gamma scalping. This has been very profitable for me because of the increased volatility. However, if IV was to plummet, coupled with the impact of theta, my strategy may fail, as I would be challenged to earn enough from the scalp trades to offeset the material drop in option value. This is the reason why I'm considering experimenting with the e-mini or SSF as a hedge. Although a major problem for me is the fact that I don't know of a prop firm that allows hedging with futures. There are a few that allow hedging with options. Walt
If you hedge with futures, you'll only get the risk-free rate. (Which you can get by purchasing only the T-Bills).
The option Greeks can significantly reduce your exposure if you are willing to give up some of the initial upside. The ThinkOrSwim platform has a nice little "theoretical price" feature so you can see how the Black-Scholes option model would respond for different moves. This is one of the main reasons that I prefer the option over a stock. If I hold a call option with a strike that is slightly out of the money and my stock gaps down big, I lose less than I would with the underlying...and the rate I lose slows down the further it moves against me. Conversely, if it moves in my favor, I accelerate my gains until I am 1:1 with the underlying. If you are a longer term player, then options are more difficult due to time decay/rolling, but I tend to hold for a few days to a few weeks, so a 3-6 month option is an excellent proxy for the underlying.
I am trying to find the holes in the equivalent positions, so I did some homework. I took GRMN stock, trading at 28.14 intraday and used Scottrade Optionfirst's PL calculator to calculate comparative values at various points from inception to expiration, and finally the equivalent call position with a 40% drop in IV. My study suggests the following: 1) The PL values for all scenarions are virtually identical during the process 2) IV seems to be less of a factor the closer to expiration you get 3) The impact of a 40% drop in IV does not have that much of an impact on the call position. ( I was thinking otherwise) 4) It looks like time decay is not a significant factor. 5) the most important part of the quivalent is movement of the stock, just like owning stock. Here is the study:Garmin Stock @ 28.14 IV of put 57.44 Amount invested stock and put 2924 Buy Dec 25 put 1.10 DEc 25 call IV of call 64.47 Synthetic married position cost 421 l PL Values at inception P&L P&L PL Stock & put 25 call 25 call 40% IV drop Stock price 43 days to expiry 43 days 43 days 15 -347 -369 -370 20 -328 -341 -369 25 -189 -188 -320 28.14 0 0 0 30 143 139 58 35 592 578 555 40 1080 1061 1055 PL Values 21 days from expiration P&L P&L PL Stock & put 25 call call 40% IV drop Stock price 21 days 21 days 21 days 15 -421 -369 -370 20 -415 -388 25 -284 -215 -312 28.14 0 30 94 155 130 35 509 632 630 40 1078 1130 1130 PL Values at expiration P&L P&L PL Stock & put 25 call 25 call 40% IV drop Stock price Expiry Expiry Expiry 15 -421 -370 -370 20 -421 25 -369 -369 -369 28.14 0 30 78 130 130 35 578 630 630 40 1078 1130 1130 Criticism and comments welcome, It would help me and and others trying to get our heads wrapped around equivalent positions.
If you have a good modeling program, an easy way to see the equivalence of equivalents is to graph the entire position. IOW, go long the natural and go short the synthetic. If they are fairly priced, the resultant graph will be a horizontal line.
Spin, The graph shows everything from a smile to a upward sloping line at diff. dates. The PL calcs are the same at each price level, but vary from +8 to -60 if I move the dates, maybe just the estimation factor??
Can't explain what you're looking at since I don't use that platform. Might have access to it but let's see if we can figure it out here. The premise is that if you graph the opposing positions of a synthetic, they should negate and result in a horizontal line. A NP = a CC so the position would be either NP-CC or CC-NP So you should be looking at: +100 shares -1 Dec 25 call + 1 Dec 25 put (or the same 3 legs with the +/- sign reversed) This is an easy example since all ET-ers know the above is a conversion (g) and it locks in the risk free rate of return (the horizontal line) Clear as mud?
That is what I did, and I was expecting the horizontal lines. The calculated amounts were all linear, and most pretty close to zero, so the answer may be the graph just does not present things clearly, or I am looking at it wrong. Ill look around and try some calculators online, maybe cboe, oic, or optionlab. Thanks for checking this Tom
A horizontal line close to zero would be the correct result. The amount above/below zero would be the carry cost. Most of this is purely academic - just an easy way to demonstrate to someone that positions are equivalent.
This is not a discussion where extreme views can be argued - as they can in politics. The earth is not flat. The CC and NP are equivalent. Based on the assumption that you initiate the positions when the option prices are efficient. There is always going to be a difference of a couple of pennies - depending on which prices you execute the trades. But these are equivalent as far as the retail trader is concerned. Mark