Hedging with puts - Confused

[arthanos]

I don't know all to much about options and i'm slightly confused about this.

Let's say, you hold 100x a stock that's valued at 50$, you but 1 ATM put strike 50 as a hedge, its atm, so -0.50 delta, as far as i am aware, this makes me fully hedged, as in, i can lose no more than the premium paid up front.

Now i read in various places, to be fully hedged, 2 atm puts are needed, as they are -.50 delta, this got me slightly confused, an atm put with same strike as the stock, how can one possibly NOT be fully hedged? What am i missing here?

So, ok, let's say, you hold 1 ES fut long, and want to be fully hedged overnight, how many SPY puts would one buy to achieve that?

 

[Dolemite]

I don't know all to much about options and i'm slightly confused about this.

Let's say, you hold 100x a stock that's valued at 50$, you but 1 ATM put strike 50 as a hedge, its atm, so -0.50 delta, as far as i am aware, this makes me fully hedged, as in, i can lose no more than the premium paid up front.

Now i read in various places, to be fully hedged, 2 atm puts are needed, as they are -.50 delta, this got me slightly confused, an atm put with same strike as the stock, how can one possibly NOT be fully hedged? What am i missing here?

So, ok, let's say, you hold 1 ES fut long, and want to be fully hedged overnight, how many SPY puts would one buy to achieve that?

There is time value in your put bought. So that put you bought atm has to overcome this value paid until it becomes deep enough in the money to move 1 for 1 with the stock. As an example if you have a stock at 50 with a 50 put strike atm costing 2, if the stock drops to 49 the put may be worth 2.50 which means after pulling out the 2 you paid you only received .50 of the full 1 the stock moved down.

I trade SPX and which is 1 for every 10 spy options and I believe /ES futures is half that so it would be 5spy options for 1 /es contract. However, you would probably be better off just buying an ES fut option which eliminates the tracking discrepancy.

 

[arthanos]

There is time value in your put bought. So that put you bought atm has to overcome this value paid until it becomes deep enough in the money to move 1 for 1 with the stock. As an example if you have a stock at 50 with a 50 put strike atm costing 2, if the stock drops to 49 the put may be worth 2.50 which means after pulling out the 2 you paid you only received .50 of the full 1 the stock moved down.

Still not fully getting it

ATM put , so -0.50 delta, stock drops 1$, put gains 0.50$, put has the exact same strike as stockprice, in that case i am still not understanding how 1 atm put with same strike would not make me fully hedged (besides the costs of the put premium).

So i'm seeing different opinions, some say you need 2 ATM same strike puts to hedge, others say 1.

I don't get this as this should be basic info for anyone with option knowledge?

 

[Dolemite]

Still not fully getting it

ATM put , so -0.50 delta, stock drops 1$, put gains 0.50$, put has the exact same strike as stockprice, in that case i am still not understanding how 1 atm put with same strike would not make me fully hedged (besides the costs of the put premium).

So i'm seeing different opinions, some say you need 2 ATM same strike puts to hedge, others say 1.

I don't get this as this should be basic info for anyone with option knowledge?

I think what you are missing is the time value of the atm option and the fact that the delta of the put you buy will change as the price moves (this is the gamma). As the stock drops, the same put you bought might change in delta from .50 to .75 . Example: 100 shares of SPY at 192 and the 192 put at $2. That $2 is all time value and what you will find is that with SPY dropping to 191 the put may only be worth $2.50 so subtracting out the time value you bought up front of $2 you would only have .50 of protection while SPY dropped $1. However with SPY at 192 you might be able to get a put at the 200 strike for $9. It will have a higher delta so it will track more closely with the SPY drop. (all numbers are examples not real prices).

 

[arthanos]

I think what you are missing is the time value of the atm option and the fact that the delta of the put you buy will change as the price moves (this is the gamma). As the stock drops, the same put you bought might change in delta from .50 to .75 . Example: 100 shares of SPY at 192 and the 192 put at $2. That $2 is all time value and what you will find is that with SPY dropping to 191 the put may only be worth $2.50 so subtracting out the time value you bought up front of $2 you would only have .50 of protection while SPY dropped $1. However with SPY at 192 you might be able to get a put at the 200 strike for $9. It will have a higher delta so it will track more closely with the SPY drop. (all numbers are examples not real prices).

I understand delta changes as the price goes up or down, i understand all of what you are saying.

But you are basicly stating, that 1 ATM option with SAME strike as stockprice, does NOT fully hedge you, and i see your point, as an atm option won't move 1 on 1.

But that's also the part i am not following, because a stock at 50, and 1 atm put with strike 50, as far as i know, this is a full hedge to always be able to sell the 100x stock for 50$ minus timepremium paid for put.

I'm clearly missing something here, anyone with a mickey mouse explanation?

 

[diogenes7]

Your put will give you the 1 to 1 protection you're looking for up until it expires, but minus the time value (the $2 you paid for the ATM put) that will evaporate as the expiration date approaches.

In other words, let's say by expiration your $50 stock has moved down to $49. Your put option would be worth $1, which is the 1 to 1 protection you bought when you paid $2 in time premium for the option.

Similarly, if the $50 stock has dropped to $45 by expiration, your put will be worth $5, which, again, is the 1 to 1 protection you bought when you paid $2 in time premium for the option.

 

[arthanos]

Your put will give you the 1 to 1 protection you're looking for up until it expires, but minus the time value (the $2 you paid for the ATM put) that will evaporate as the expiration date approaches.

In other words, let's say by expiration your $50 stock has moved down to $49. Your put option would be worth $1, which is the 1 to 1 protection you bought when you paid $2 in time premium for the option.

Similarly, if the $50 stock has dropped to $45 by expiration, your put will be worth $5, which, again, is the 1 to 1 protection you bought when you paid $2 in time premium for the option.

Right, this is what i figured, and is basic knowledge as far as i am aware, but as i said already, i don't know the fine details about options.
So basicly, 1 x atm put = full hedge of 100 x shares - premium

Then im still left wondering why several people say you need 2 atm puts to be hedged.

 

[FXforex]

I don't know all to much about options and i'm slightly confused about this.

Let's say, you hold 100x a stock that's valued at 50$, you but 1 ATM put strike 50 as a hedge, its atm, so -0.50 delta, as far as i am aware, this makes me fully hedged, as in, i can lose no more than the premium paid up front.

Now i read in various places, to be fully hedged, 2 atm puts are needed, as they are -.50 delta, this got me slightly confused, an atm put with same strike as the stock, how can one possibly NOT be fully hedged? What am i missing here?

What you are missing is the astronomical cost of the puts if they are used as you posted.

 

[SIUYA]

Then im still left wondering why several people say you need 2 atm puts to be hedged.

There is delta hedged - you will need 2 puts - and this can be regularly adjusted or rehedged with movements in the underlying....simply because of the strike you chose to use. (Delta 30 would require 3 options, Delta 80 to 100 only 1)
and
There is absolute underlying hedged with 1 put whereby you hedge for 'large' or at expiry adverse movements on the underlying - however the dynamics of continually rehedging dont really apply here.....and you want to make sure the strike gives you the hedge you would require should such a move occur.

Kinda depends on if you want to rehedge with movements in the underlying or simply hedge for a large movement. (the later sounds like what you want)

 

[timbo]

Hey arthanos,

The hedging you're talking about isn't the same hedging used in modeling. Pricing models assume no risk. The put delta assumes you have positions in the underlying and call.