cheaply and fully hedge equities?

P

propseeker

given long stock and a desire to remain cheaply and fully hedged for periods of a week or up to a year, what are the best heding strategies that are possible with options?

the ideal, to be able to exit stock and options for small win, breakeven or very small loss after commissions.
 
Collars lock in a profit range b/t two strikes and are most likely to fit your requirements. They have a capped upside and a protective floor.

There are many other possibilities but they have a variety of risk profiles. The beauty of the hedge is in the eyes of the beholder.
 
ok, thanks for the reply.

so, by collar, i'm assuming you mean long put/short call.

the thing is, i'm looking to put this on hedged from the onset, not from the vantage point of protecting profits. the way i understand a collar to work, is after x run of your long stock you limit downside with your put, and finance with the short call as well as limit upside using different strikes (vice versa for short stock). your profit lies in between those two strikes.

so, i'm guessing i need to do something similar, but using the same strike for the long put/short call? from reading, i think this is essentially called a conversion. long stock/long put/short call.

does this sound right for creating a low cost hedged position: a conversion?
 
I don't think you have a clear idea of what you want to do in the context of reality. Why, if you're putting on the position now and want that profile, would you long the stock to begin with, and not just do a collar outright. And, if as you say, a collar is not what you are looking for, I'm not sure what you are looking to do as far as "cheap" hedging strategies are concerned.

If you're going to to create a syntetic underlying, why are you putting on this position to begin with? Why don't you just unwind? It doesn't seem to be that you are making an attempt at arb, so I'm not sure what you're trying to do.
 
Quote from propseeker:

[so, by collar, i'm assuming you mean long put/short call.

the thing is, i'm looking to put this on hedged from the onset, not from the vantage point of protecting profits. the way i understand a collar to work, is after x run of your long stock you limit downside with your put, and finance with the short call as well as limit upside using different strikes (vice versa for short stock). your profit lies in between those two strikes.

so, i'm guessing i need to do something similar, but using the same strike for the long put/short call? from reading, i think this is essentially called a conversion. long stock/long put/short call.

does this sound right for creating a low cost hedged position: a conversion?
More...
I don't think a conversion is what you want because simplistically, it locks in the carry rate, if you're lucky to get it (I'm ignoring dividend situations). And given today's carry rate, what does that get you? More practically, if you add up the cost of the position (buy stock, sell call, buy put) and it's less than the strike of the options, that's your profit. It's risk free peanuts, other than pin risk.

Your understanding of a collar is correct. A collar can be put on at any time and can be done by legs, assuming one has that ability. A collar is equivalent to a vertcial so one would do a vertical - 2 legs rather than the 3 of a collar if initiating a position... and a vertical may or may not be what you're after.

The gist of hedging is that you have to give up to get. IOW, risk and reward go hand in hand. If you want to protect a long position, you buy puts. They cost. If you want the protection to be cheaper, you have to sell something to bring in premium. The collar does that but it limits upside. If you want less cost or more upside (to a point), for example, you can overwrite calls or call spreads above to limit the downside risk more/enhance a trading range but then you take on upside risk above a certain pojnt.

It all depends on the risk graph you're comfortble with as well as your ability to manage that risk.
 
Quote from Chelsea_FC:

I don't think you have a clear idea of what you want to do in the context of reality... If you're going to to create a syntetic underlying, why are you putting on this position to begin with? Why don't you just unwind? It doesn't seem to be that you are making an attempt at arb, so I'm not sure what you're trying to do.
More...
in reality, i do have a clear idea, hence my question. to answer yours: it's an arb.
 
Quote from spindr0:

I don't think a conversion is what you want because simplistically, it locks in the carry rate, if you're lucky to get it (I'm ignoring dividend situations). And given today's carry rate, what does that get you? More practically, if you add up the cost of the position (buy stock, sell call, buy put) and it's less than the strike of the options, that's your profit. It's risk free peanuts, other than pin risk.
More...
firstly, again, thanks for the info. a few questions re: the above if you'll oblige me...

so, with a conversion, there is only pin risk? i'm assuming when you say 'lucky to get it' you're referring to execution risk? you said ignoring dividends, let's assume they occur before a strike, will the options typically price that in? it sounds like what i'm looking for, upside and downside are nullified with cost/risk really limited to execution and getting pinned, correct?

i'm not looking to make money directionally with stock, nor options. this is a leg of a larger arb, so admittedly, it doesn't make a lot of sense from solely the context of 'using options to hedge stock', but serves the same purpose conversationally.

The gist of hedging is that you have to give up to get. IOW, risk and reward go hand in hand. If you want to protect a long position, you buy puts. They cost. If you want the protection to be cheaper, you have to sell something to bring in premium. The collar does that but it limits upside. If you want less cost or more upside (to a point), for example, you can overwrite calls or call spreads above to limit the downside risk more/enhance a trading range but then you take on upside risk above a certain pojnt. It all depends on the risk graph you're comfortble with as well as your ability to manage that risk.
More...
i run an independent equity stat arb book, doing a lot of index, complex synth, and pair arb, so i know my way around valuations and the costs/tradeoffs of hedging. i'm looking to bring in an options element for... well, 'difficult situations'. sometimes inventory can get bloated, liquidity can falter, and spreads can blowout... all at the same time. so, if i can cheaply nullify directional exposure using options then i'll have added a useful tool to my quiver.
 
Quote from propseeker:

so, with a conversion, there is only pin risk? i'm assuming when you say 'lucky to get it' you're referring to execution risk? you said ignoring dividends, let's assume they occur before a strike, will the options typically price that in? it sounds like what i'm looking for, upside and downside are nullified with cost/risk really limited to execution and getting pinned, correct?

i'm not looking to make money directionally with stock, nor options. this is a leg of a larger arb, so admittedly, it doesn't make a lot of sense from solely the context of 'using options to hedge stock', but serves the same purpose conversationally.

i run an independent equity stat arb book, doing a lot of index, complex synth, and pair arb, so i know my way around valuations and the costs/tradeoffs of hedging. i'm looking to bring in an options element for... well, 'difficult situations'. sometimes inventory can get bloated, liquidity can falter, and spreads can blowout... all at the same time. so, if i can cheaply nullify directional exposure using options then i'll have added a useful tool to my quiver.
More...
Yes, dividends are priced in. I didn't mean to imply that they were a special situation. Since you're on the learning curve, for ease of understanding I was just trying to keep the number of variables to a minimum.

For most, conversions and reversals are not realistic because under theoretical conditions, they should lock in the carry rate. Even with a mispricing (which retail is unlikely to find), the yield isn't going to be much more. Add in commissions and they're really not practical unless you're legging in. Take a look at some real time conversions and reversals for a number of stocks and you'll see the numbers.

However.... given you add'l info as to wanting to hedge to nullify arb risk then the collar and other info is irrelevant. The conversion (or reveral if stock is short) will lay off the directional risk to the other players. You're not most and whether you lock in the carry rate or some part of it (even break even) may very well be totally irrelevant since the principal is your concern. If so, execution is not much of a risk and the only problematic event other than pin risk that I can think of would be early assignment if the short leg gets near parity (deep ITM or close to expiration).

Perhaps some with arb experience (I have none) can contribute something useful than this :)
 
It kind of sounds like you want to be able to purchase/sell a stock at a given date and ensure the same price in 'x' amount of time. If this is the case, yes a conversion could do this cheaply. Alternatively you could use a CFD, SSF, index futures, swap, or basket of stocks to hedge.

Is this what you have in mind or am I not understanding correctly?
 
You must log in or register to reply here.
Back
Top