delta hedge with ITM call...

C

cdcaveman

just being curious here.. thinking about potential trades... say instead of using the underlying i use a deep in the money call option... example

+1 bac Jan14 call option strike price 7 with a delta of .68
-- meaning that a purchase of 1 call option would give me .68 percent of 100 shares of stock..

then sell several out of the money wing options say in october
-4 bac oct 12 call option strike price 10 with a delta of .17
-- this would put me delta hedged.. 4x17=68 (please correct me if i'm wrong)


so then.. i would have to calculate what could possibly happen..
1.. the stock rises--- i buy either the underlying or another call- i would think more stock would be easier to exactly hedge.. therefore i would need to know exactly how much money i would potiential need to completely hedge this position and keep it in my account.. i'm naked 3 call options so their for i could potientially need 300x 10= 3000 in my account to cover the naked calls..
2. i would always have to worry about jumps being that i'm short so much volatility.. i'm not so worried about the banks shooting to the moon at this point. but nothing is impossible..
a little correlation i'm sure will help in my book... i short puts on the vixy to own volaliity.. get long vixy.. thats not a direct correlation.. but its my way of being long vol in a general way..


i would love to hear some experienced traders thoughts on delta hedging with itm calls... is the spread a killer? if your long term bullish on a bank recovery but short term bearish.. is this not a good way to continually reduce your position in the bank.. basically constantly selling more calls out of the money to get real negative theta.. of course your long alot of vols but thats what i want advice on...
 
You can Delta hedge with DITM calls but they're only really effective for small moves in the underlying. If you're really neutral on the stock you're better off shorting the calls and using stock to adjust your Deltas instead of long options. Overall its a really shitty trade for a few reasons. Selling that far out for the premium you're getting is an awful way of collecting Theta. Event risk is always an issue with a naked option so getting .15 for it is no compensation at all. you're much better off moving the whole spread closer to expiration and diagonalizing it (buy back month 70-80 Delta option and selling front month as far OTM you can. With BAC you pretty much have to sell ATM to get any worthwhile premium). If you want a directional play use a vertical instead. Most people should never use naked options because once they start moving WATCH out! Keep it small and defined risk until you have a feel for options and the strategy you're using.
 
Your Delta is neutral but your gamma is not. Your construction is also backwards as pointed out by Gammahedge. Sell the front month ATM and use stock to adjust your delta.
 
To rephrase... my thoughts for buying an at the money call was to cut the cost of the trade.... so basically I would have a ratio 1x2 and hedge with the stock

.
So I would sell two calls against one itm call and as well the necessary deltas in stock. I guess another more broad question is if a itm
back month call isn't a good gamma hedge for front month otm calls what options typically are? I need to start getting the math of this stuff. I have talebs dynamic hedging in hand as well as Baird's option market making book.. there is a site called power options that constantly talks about this radio active trading strategy .. which is a covered ratio write strategy like I've been talking
 
I'm assuming you're non directional with this trade and you're trying to collect Theta? (if you're trying to be directional there are much better spreads to look at). If so there are four major issues I see with this strategy:

1) BAC is too small. Trade a larger vehicle like GS if you're into financials. You'll get killed on commissions selling shit premium.
2) You're WAY too far out in time. The Greeks aren't linear so the further out you are the less Theta you're going to get.
3) Price can sit right where it is but if the Vega gets sucked out of that long option you're going to get your face ripped off.
4) Throw Talebs book out and read one by a person who actually makes money trading options. Bittmans trading options as a professional is a great book for understanding how the Greeks interact with each other over time.

You can construct all kinds of great strategies using options but as soon as a new trader starts using longs, shorts AND stock simultaneously its a recipe for a blowout. And above all else stay SMALL no matter what you do.
 
i jumped into things when i first started trading options and i never did it again.. A good five thousand dollar loss in one trade makes for an amazing lesson... ive been buying leaps and ratios in leaps on a very small scale on stocks im either directional on or im just long vol with a wrangle on things that have been quite for a while... taleb is one of my fav authors but dynamci hedging is dated... Ill read your suggestions... ive started reading up more and more on gamma hedging... Im still so new i dont do anything with out a real good map... And still i consider the map isnt the territory ill have to read more the reason i was using bac as an example was cause i figured buying deltas on an 8dollar stock is cheaper then a 100 dollar stock im only trading a 20 thousand dollar account... So im always theroizing small trades
 
Nothing wrong with trading BAC you just have to watch out for fee's and commissions because they'll eat you alive. At 20K you won't be able to daytrade so a .15 option you sold in the morning may be offered at .03 in the afternoon and you won't be able to bail out of it. I used to trade a lot of cheap options too until I realized how much I was giving to Interactive Brokers in commissions and fees.
 
Quote from Gammahedge1:

I'm assuming you're non directional with this trade and you're trying to collect Theta? (if you're trying to be directional there are much better spreads to look at). If so there are four major issues I see with this strategy:

1) BAC is too small. Trade a larger vehicle like GS if you're into financials. You'll get killed on commissions selling shit premium.
More...

I trade GS all year, every week.

But I paid my dues to gain knowledge of how the traders move GS; I am willing to sell this knowledge for a monthly retainer of a % of options gains. lol
 
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