Hedging big overnight moves?

[heech]

Quote from spindr0:

OK, a recap (g). In your earlier posts, you indicated that:

And an excellent recap it was. Not sure whether the "pseudo" shoe fits when you go out to the Iron Condor, or at least fits well enough for it to be useful... but it's a nice alternative way of thinking of it.

But yes, a pseudo-strangle seems like a good description of it. Covered call = naked put, so... yea.

And if it's a strangle on a market index, you won't have to open and close it daily. It will be in place, protecting you until expiration and you won't incur all the slippage from daily hedge trading.

But what about theta? I just assumed in my mind (without much thought) that theta loss would be greater by expiration than slippage/hedging costs. But with the nickel spreads out there, maybe that's not the case...

 

[luckyd1976]

Quote from jwcapital:

When I used to trade covered calls on the ES (s&p 500 eminis), I would cover my downside by buying OTM puts. Then, come the morning (usually after 9:30AM when the Futures options are more liquid), I would close out the puts either at a profit or break-even. You can repeat this nightly and cover yourself over the weekends. I believe that if you try to use ATM puts that your "insurance" may be too costly--I never really analyzed this possibility. Perhaps others here can comment.

JWCapital,

First very good post here. CovCalls --> Into temp short term Collar trades. What a great idea.

But how partical is it? Do you lose much on transaction costs here for your extreme short term Insurance and Bid/Ask spread???

 

[heech]

Quote from luckyd1976:
First very good post here. CovCalls --> Into temp short term Collar trades. What a great idea.

Assuming that the goal is to end up in the covered call again (which is my goal), rather than holding the collar indefinitely... I'm not sure how this works.

What if price gaps up significantly overnight...? Your covered call will retain the same value, but now your put (even if OTM) will have lost significant value.

This is why I would think a strangle would be the only way to go, so that you're protected both upside and downside.

 

[spindr0]

Quote from luckyd1976:

CovCalls --> Into temp short term Collar trades. What a great idea. But how partical is it? Do you lose much on transaction costs here for your extreme short term Insurance and Bid/Ask spread???

It's a good idea in terms of setting a floor under for catastrophic protection (gaps) but it's not practical at all. Between the B/A slippage and the commissions, you add a lot of drag to your position and have to be more right in your timing with the underlying in order to overcome those add'l costs. And then there's that pesky little problem of the losses down to the strike.

You can turn the position into a conversion (or a reversal if you're short the stock) for overnight protection and opening surprises won't bag you. But that's has the same inefficient results. In the long run, it's always better to trade clean and avoid all the complications and add'l costs of legging in and out of protection. If you want protection, buy the put and keep it in place if you're trading.

If it's a time dependent position like a covered call and you want protection, skip the adding and subtracting protection idea and trade spreads, the equivalent of a collar (CC + put = collar = vertical spread if options at diff strikes).

 

[spindr0]

Quote from heech:

What if price gaps up significantly overnight...? Your covered call will retain the same value, but now your put (even if OTM) will have lost significant value.

A collar on long stock is equivalent to a bullish vertical spread so if price gaps up, you do alright but just not as well as you would have had you not bot the protective put. It's the gap down that hurts the collar the most but far less than having no protective put at all.

 

[heech]

Quote from spindr0:
A collar on long stock is equivalent to a bullish vertical spread so if price gaps up, you do alright but just not as well as you would have had you not bot the protective put.

I'm talking about versus the original covered call only position, which is my "real" strategy position. If you look at just the "put" leg... the loss there is pretty expensive insurance!

I think the cost of slippage would be more manageable (and at least 'known')...

I'm doing some simulations based on SSO strangles at the end of day... will update next week.

 

[spindr0]

I'm talking about versus the original covered call only position, which is my "real" strategy position. If you look at just the "put" leg... the loss there is pretty expensive insurance!

I'm not exactly sure what our differences are, if any. Yes, puts are expensive if they decay or expire worthless. But if the underlying craters 10 or 15 pts, those puts will look like a pretty clever "waste of money."

The point that I was trying to make was that if you bought bullish vertical spreads every day of your life and everyone of them gapped up, you'd make a pretty decent piece of change, despite the gap - just not as much as had you not bot those puts.

The short answer is that option strategies tht limit risk also limit reward. You have to find your own acceptable balance b/t the two. Pick your poison - less profit to the upside or more loss to the downside

 

[heech]

Just as a follow-up... my early impression is that this isn't as easy as I hoped.

Part of the problem is that I have overnight VaR of $20k-$30k... and to hedge that effectively, with OTM options, I figure I need to buy/sell something like 1k contracts in each leg.... every day! I thought that by itself would be too expensive. But I just came across Option House, which at least solves the commissions problem.

Now, I still have to choose the right stock. Here's what I figured out.

Ask/bid spread in options on the SPY are 5%... so losing that every day will also be extremely painful. Something with 1%-2% spread would be nice. I'd also like something that would let me implement a strangle that moved substantially when the underlying moved. Is there anything that will move +10% if the indexes moves 5%, for example?

 

[spindr0]

Just as a follow-up... my early impression is that this isn't as easy as I hoped.

As the money involved get larger, the difficulty increases

Is there anything that will move +10% if the indexes moves 5%, for example?

Any stock with a beta of 2.0 will move twice as much as the market index.

 

[heech]

Quote from spindr0:

As the money involved get larger, the difficulty increases

Any stock with a beta of 2.0 will move twice as much as the market index.

Yes, but a stock with beta of 2.0 will also move down twice as much as the market index...

Sorry if I wasn't clear, but I'm really needing something that hedges directions in either directions. Thus the strangle. I want to get paid (+10%) for a big overnight move (+5% or -5%).

Maybe that's just fantasy...?