Effective Hedging

D

dragonman

With respect to directional trading in equity options (long positions, either by long single options, long vertical call spreads, short vertical put spreads, etc.) what do you think are the effective hedging alternatives that generally provide a reasonable protection without substantially hurting the returns?

In order to effectively hedge against a decrease in equity prices I assume that the alternatives include long option positions on assets that have a distinct negative correlation to equities (and there are not so many such assets, such as TLT or VIX) and also direct bearish option positions on equities or equity indexes, but any of such alternatives hurt the returns substantially. Of course there could be more alternatives, and I just want to hear your thoughts and tips about possible alternatives and your experience in this matter. Thanks guys.
 
why would you hedge in an options strategy? the beauty of using options in the first place is that you can so easily control exactly your equity at risk while still controlling substantial leverage. You should be able to use position sizing to control risk and exposure, can't imagine a scenario where hedging options would be appropriate.


Equities, of course, would be another matter...
 
Quote from HuggieBear:

why would you hedge in an options strategy? the beauty of using options in the first place is that you can so easily control exactly your equity at risk while still controlling substantial leverage. You should be able to use position sizing to control risk and exposure, can't imagine a scenario where hedging options would be appropriate.


Equities, of course, would be another matter...
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Just to make sure that I understand you correctly -- do you suggest that I should initially create the option strategy based on my risk assumptions regarding the specific underlying (for example, if I fill more comfortable with the company's downside than with its upside potential I should short ATM vertical put spread instead of buying ATM long calls) and that I should generally not add to this any additional hedging strategy?
 
huggie - i agree w/ you that there's no need to hedge IF the options you're holding are a small % of your overall port however if you're holding a lot of calls for example and a rogue swan comes out of nowhere you've got a big problem.

to the OP, i'd suggest taking a small portion 10-15% and buy otm options w/ 2-3 months to expiry and roll these over throughout the year. yes you will lose $ on these but that's the point of a hedge. better to lose a little money overall b/c of hedges than lose everything w/o them.
 
sorry guys, let me be more clear....when executing options strategies there are a lot of various structures you can use to control risk. To use one simple example, instead of simply holding naked long calls you can hold ATM calls while selling OTM calls (if you are bullish)....i suppose you can call this hedging, but i just think of it more as a specific options strategy.

Or if you want to sell puts, you can sell ATM puts while buying farther OTM puts, controlling your downside risk. Again, i guess this could be considered hedging but I just consider it one of many specific options strategies/structures that help you control your risk explicitly.
 
Quote from HuggieBear:

sorry guys, let me be more clear....when executing options strategies there are a lot of various structures you can use to control risk. To use one simple example, instead of simply holding naked long calls you can hold ATM calls while selling OTM calls (if you are bullish)....i suppose you can call this hedging, but i just think of it more as a specific options strategy.

Or if you want to sell puts, you can sell ATM puts while buying farther OTM puts, controlling your downside risk. Again, i guess this could be considered hedging but I just consider it one of many specific options strategies/structures that help you control your risk explicitly.
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an do you think that in addition to create the strategy as you suggested, making an additional hedge (for example with buying OTM options as a hedge with 15% of the portfolio) is not effective since you would create a "double hedging" which is not necessary and will reduce the returns substantially?
 
It's all wildly volatile and ineffective...
Unless you are hedging stocks directly on a sector level...
Within large long/short baskets (like 100 positions each side)...
And doing it very intelligently.

You must have the infrastructure to manage long/short baskets...
In real time...
And hedge bank securities with bank securities...
REITs with REITs...
Tech stocks with very similar tech stocks, etc
You get the picture.

Otherwise, just make directional bets.

And unless you are selling options and working the spread...
You are just setting money on fire.
 
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