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Not an options guy; however, need some sort of hedge against vol spikes
- Thread starter garchbrooks
- Start date
Quote from psytrade:
volatility is a measure of how liquid the Market is as well as fundamentally how uncertain the directional bias is.
Its hard to analyze liquidity nowadays in equities (maybe in other futures too) because HFT distorts it - See Joe Saluzzi's articles.
I don't agree with the hard-to-analyze assertion for the status-quo of a given stock. There's only so much liquidity available in any given market because the HFT participants can only absorb so much risk and they don't want adverse-selection from informed participants. My guess is that there are enough news events per year per stock (on account of earnings alone) that give you a loose-idea of how much risk a given set of MMs will tolerate. MMs having a kind of risk tolerance is just an undeniable fact of the market. The risk they can absorb dictates how much they offer, and you can get a feel for this quantitatively, at least for the status-quo.
What can't be analyzed, though, is what happens when news comes in and exhausts the risk thresholds market makers are willing to absorb. This is basically a "what happens when we're in the tail region" type thing. But, ignoring the tail-region behavior for any given stock, you -can- say there's going to be a burst in volatility. But is it so unreasonable then to bet on more upside for volatility then? And to what extent? A trailing stop long-vol bet through VXX??
Quote from illiquid:
Aren't pairs trades assumed to be mean reversals and rising volatility/headline risk will just work against those? Isn't the question like asking how to hedge a long position when the stock keeps dropping? Or am I being to simplistic?
In theory, if you have a beta neutral portfolio, the volatility shouldn't make a difference for a pair-trade, at least beyond some tight, well-maintained band. This isn't the case in practice, though. Particularly when stochastic shocks aren't industry/sector wide, but specific stock wide. It could be as simple as one member of the basket is an index component, whereas the other one is less liquid and not an index component.
I'm a options guy. Through the years, I have found volatility spikes coincide with down markets. When I traded stocks over 10 years ago, I typically collared the portfolio as best I could. I did not short at all. I used options--slightly OTM long puts coupled with a little further OTM short calls that help pay for the puts. So, since volatility spikes usually occur most frequently with downside slides, I am protected to an extent. My profit depends on how far OTM I place the short call and movement of the underlying. A couple of years ago, I tried to hedge my option trades with volatility futures and futures options. I was very unsatisfied. I didn't get enough movement compared to the spot VIX.
When I collared, my profits weren't as high (tried to include dividend paying stocks to also hedge), but my losses were much smaller--so I was content.
You can do the same thing with long/shorts. Look at your longs as portfolio one and look at the shorts as portfolio two. Both portfolios can be collared.
When I collared, my profits weren't as high (tried to include dividend paying stocks to also hedge), but my losses were much smaller--so I was content.
You can do the same thing with long/shorts. Look at your longs as portfolio one and look at the shorts as portfolio two. Both portfolios can be collared.