breakevens

[erasmus]

i'm clear on what these mean when you simply are running an option position without any delta hedging.

I understand When you are long gamma and delta hedge, you in essence end up buying low and selling high. You will make back your decay if the actual volatility is higher than that which was implied when you bought the option. So what do breakevens tell you when you are delta hedging?

(the only thing i can think of is that a breakeven on say an overnight ATM call implies hhow far the market thinks spot will go up, so it can give you an idea of what level you can let your deltas run to before clearing them.)

 

[dagnyt]

Quote from erasmus:

i'm clear on what these mean when you simply are running an option position without any delta hedging.

I understand When you are long gamma and delta hedge, you in essence end up buying low and selling high. You will make back your decay if the actual volatility is higher than that which was implied when you bought the option. So what do breakevens tell you when you are delta hedging?

(the only thing i can think of is that a breakeven on say an overnight ATM call implies hhow far the market thinks spot will go up, so it can give you an idea of what level you can let your deltas run to before clearing them.)

1) Forget about break-even points. They are used by people who (don't know any better) and plan to hold options until they expire.

2) When 'delta hedging' your break-evens change with every trade. Again, there is no need to use them.

3) Why did you make the trade in the first place? If you did it because on option was undervalued relative to the other, then your goal is to exit the trade when that discrepancy disappears. If you did it to gain gamma, allowing you to 'buy low and sell high', then there is no break-even and you simply exit the trade when the cost of owning is too high, or perhaps when the options become too far out of (or in) the money to provide much gamma.

4) You WILL NOT necessarily make back your decay when the realized volatility exceeds the IV paid - unless the stock moves up and down, giving you profitable scalps. And don't forget, sometimes you miss a sell or buy by a few pennies. that's even worse - you get the move, but you fail to collect.

If the stock goes down day after day and you buy some every day, there's a chance you will have bought too much too soon and not earn a profit.

Mark
http://blog.mdwoptions.com/options_for_rookies/