Continous hedging as a rachet device to lock-in profits

botpro · Mar 20, 2016

If by hedging one can manage to get 0 then this is IMO still very valuable...

Because then one just would need to add an "offset" to the calculations and by this would make "0 + offset" profit... (just thinking loud about mathematical possibilities...

)

cvds16 · Mar 20, 2016

you really would better read some decent book on optionstheory
try this one:

ironchef · Mar 20, 2016

botpro said:
ironchef, I'm busy with other stuff at the moment, but wonder what you mean by "~+- zero profit"?

botpro,

I actually just simulated hedging a long call. Since I used excel to generate my Monte Carlo points (~3000 each time), I was not able to get enough accuracies to get the true Monte Carlo outcome, so every simulation was slightly off but after enough tries I was able to see things approaching zero. However, I was using the current risk free rate which is < 1% and my computation did not have enough to converge to a resolution < 1%.

I relooked at the Black Scholes derivation, it assumes a no arbitrage world and that one can hedge continuously, then, the portfolio of (options - delta*stock) = earns the risk free rate of return.

Two questions for everyone:

1. If that is true, my simulation should approach the risk free return instead of zero?

2. If I short options, in a BS world, if I continuously hedge, would I then lose the risk free rate of return since in that case I am the counter party?

Any comments are welcome.

blueplayer · Mar 20, 2016

ironchef said:
botpro,

I actually just simulated hedging a long call. Since I used excel to generate my Monte Carlo points (~3000 each time), I was not able to get enough accuracies to get the true Monte Carlo outcome, so every simulation was slightly off but after enough tries I was able to see things approaching zero. However, I was using the current risk free rate which is < 1% and my computation did not have enough to converge to a resolution < 1%.

I relooked at the Black Scholes derivation, it assumes a no arbitrage world and that one can hedge continuously, then, the portfolio of (options - delta*stock) = earns the risk free rate of return.

Two questions for everyone:

1. If that is true, my simulation should approach the risk free return instead of zero?

2. If I short options, in a BS world, if I continuously hedge, would I then lose the risk free rate of return since in that case I am the counter party?

Any comments are welcome.

Ironchef, for point number 2, yes if you are a dealer you will lose the risk free rate on the option trade however because you sold it, the money you got from the sale will earn the risk free rate in your bank account, so you will come out to exactly zero.

ironchef · Mar 20, 2016

blueplayer said:
Ironchef, for point number 2, yes if you are a dealer you will lose the risk free rate on the option trade however because you sold it, the money you got from the sale will earn the risk free rate in your bank account, so you will come out to exactly zero.

Ah! Great answer! I missed that part!

So, if I were the buyer, I spend x and will get x + rt back at the end. It is the same as if I deposit x in the bank and get x + rt back. What does the seller get? He pays the risk free rate for the use of the funds. Make sense. :finger:

Thank you blueplayer.

kcgoogler · Mar 20, 2016

botpro said:
When selling options, hedging is inevitable.
There are two types of hedging:
- one-time hedging, and
- continously hedging (or dynamic delta hedging)
The second one is very interesting. It is IMO the best and also the most profitable
according to the very first few informations I read about it.
It works like a rachet device by locking-in the current profits.
The next hedging increment would be done if the position again gained in value,
for example the hedging increment would be repeated after every x% gain the set of these related positions makes.

I'm going to study this interesting trading tool.
Pls let me know of your experience or opinion about this type of hedging, especially when selling options.

Thx

hello botpro,

When you are short premium and are putting on hedges you are actually locking in losses; not profits. Since the option pricing itself is based on continuous hedging (google it up), its not really a way to locking in any gains - check your sources.

Try searching "reverse gamma scapling". Might help.

regards!
-gariki

botpro · Mar 22, 2016

Weird world!

When I in my testing framework do simulate options selling with dynamic hedging,
then I always make a profit of approximately the size of the credit.

Other people here tell that one can earn only the risk-free interest (however they might define this, because it is not given in any of the params... ie. r=q=0

).

So, what is the truth about the expected profit from options selling with dynamic hedging?

Either my logic is weird, or my code is buggy (indeed long and complicated code),
or I maybe have found a holy grail with this and the rest of the world is crazy wrong in this.
Pls just tell me what it is. Thx!

cvds16 · Mar 22, 2016

Everybody is telling you you are wrong (including several option-veterans), yet you keep insisting you are right ... what do you honestly think ...

botpro · Mar 22, 2016

cvds16 said:
Everybody is telling you you are wrong (including several option-veterans), yet you keep insisting you are right ... what do you honestly think ...

Can you make a statement about the profit one can make with options selling combined with dynamic hedging?

cvds16 · Mar 22, 2016

yes, it's zero ... that's what the whole options theory is about: you try to artificially recreate an option ... market makers use it to hedge there exposure when they buy or sell options ... Black, Merton and Scholes won the Noble prize for it ...