Option Hedging with Futures

T

toswilliam

Hello everyone. I am new to the Elite trader forum. I have been trading options for about two years now. Mainly vertical spreads / iron condors on a few select stocks and ETFs. Here is my question. I am tired of giving up so much of my premium to buy the downside insurance and want to run a strategy that I have been back testing so you can poke holes in it if you see flaws.

I will use the SPY in this example.

Say I sell a 5 lot of the SPY at the 100 strike price today for 1.55. I would collect $775.00 in premium. I then put in a sell order for one contract on the e-mini sp also at 1000. If the SPY blows past my 100 short position it would trade perfectly hedged all the way down. So that if on exp day the 5 lot of SPY is trading at 90 I would have a 5K loss on that position but a 5K net gain on the e-mini position for a total net loss of $0 and I would still collect my premium of $775.00.

This would equal almost a 4% net profit for the month. Not bad for almost no downside risk.

Here are the flaws in the strategy that I have come up with but I am still looking for input.

1) I would have to manage the e-mini contract so if it dips below 1000 a sell order would take place and if it popped back about 1000 I would have potentially unlimited risk. I would need a way to auto execute getting in and out of the e-mini contract which leads me to my second flaw.

2) Commisions eating up my collected premium moving in and out of the e-mini contract. I did the research for the past year and it actually happened fewer times than what I would have thought but there is always a chance for that to happen

3) Gap opens from either from the upside or the downside happening on open Sunday. I also back test this for the last year and it would have effected any of the trades.

What else am I missing here. Also if you can do this from the put side you can sell calls just out of the money and have a buy order in for the es at whatever strike that would be to increase your premium / profit.

Thanks for your input.
 

Attachments

This strategy is the flip side of an often discussed strategy in this forum. Use search to look at gamma scalping. All you are doing is selling premo and using the underlying as your hedge. Prev posts by iv_trader and riskarb and maverick are great places to start.
 
he's not gamma scalping, he's legging into a synthetic naked call sale (-1 emini / -5 SPY puts).

covered put = naked call sale
covered call = naked put sale

if you want to sell calls, just sell calls. you're complicating the process needlessly.
 
Thanks for the posts but I think you are missing some of the details. This is not the reverse of gamma scalping nor the same as selling calls.

If you are selling calls you need the stock to rise in value to profit. I am not interested in speculating on the direction of stock prices. I am interested in collecting premium by selling the put and only buying the emini hedge when the stock blows past my short put position. I would then buy it back if it came back to my short strike position. So basicly I am only taking on the hedge if my put is in the money.

By the way I attached the back test to the original post.
 
Search for gamma scalping, user "dmo" wrote an article in a magazine about it, link should be somewhere in Options forum. I think that article referred to long premium and trading futures around it, you want to do opposite, sell prem and trade futures around it.
 
Optionseeker

Thanks for the input. I agree this is an issue and the reason I am looking for an automated system to move me in and out of the emini position to reduce the slippage.
 
Man, if that backtest is accurate, you got a mint.

*Just a suggestion, stress test/backtest it in Sept '08. I've looked at some premium selling hedge fund returns, pardon me but I can't remember the names right now, but they all had good returns most of the other months of '08 and then bamboozled Sept '08. If you have smallish drawdown (don't think no drawdown can be expected, if the pro's cant), guess that's a good sign.
 
Kedwords

The backtest is accurate with one exception. I did not have the data available that said how many times in that day that the futures contract would have to be bought and sold but even if it were two or three times per each day you can see the it is still a profitable strategy.

Second issue is I could only use futures information for this september exp. But this should be worst case the front quarter exp would have tracked closer.
 
Quote from Kedwards:

Man, if that backtest is accurate, you got a mint.

*Just a suggestion, stress test/backtest it in Sept '08. I've looked at some premium selling hedge fund returns, pardon me but I can't remember the names right now, but they all had good returns most of the other months of '08 and then bamboozled Sept '08. If you have smallish drawdown (don't think no drawdown can be expected, if the pro's cant), guess that's a good sign.
More...

I will be doing a 2008 full year back test tomorrow and will post the results.
 
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