Option Hedging with Futures

[PocketChange]

Quote from toswilliam:

Thanks for all the input. I am still testing the strategy and this month with the exception of the 31 where I was in and out of the trade 13 times x $7 comm on each full trade and a few missed ticks brought me to -$150.00 on the day. It has blown right past the naked short position and has maintained a very close hedge. I realize this could eat up alot of premium if it stays in the channel but in this case I will probably be 4 or 5 days without and risk on coming out of the futures contract. My thoughts are now that it would probably make more sense to sell the put and the call just out of the money to collect more premium on the front end so if I get caught in a few more days like the 31st it doesn't eat through the premiums collected.

There is more variation on the emini to the spy than I would like. I am also going to test on the futures options so price would directly coorelate and be a perfect hedge. Less slippage.

It is alot of work and possibly alot of commisions but I am looking to hedge as close to 100% of my trade as possible and just collect the time decay. At current volitility selling the call and put just out of the money you would collect 2.50 on each side. $2,500 in premium even if I spend $1000.00 protecting the position after taxes I am still making 5% on the trade.

I think your on the right track using ES Options to hedge SPY options risk. From very limited data it appears at any instant in time ES and SPY are not 100% in sync. 1 ES strike to 4 strike differential.

The shot gun approach seems to work well. Scalp sets of ITM and OTM option pairs and as quickly as you can offset open new positions. These positions appear to turn every 3 - 10 days.

Biggest issue is dealing with your broker. Even though you appear to have a near 100% hedge they will not recognize the cross instrument hedge.

As far as they are concerned you are naked shorting SPY and buying ES options for cash. You will receive a premium and cash gain but all proceeds will remain encumbered until you unwind the trade.

This is a shame because the trade pair itself provides sufficient SPY premiums to pay for the ES Hedge and profits to boot.

I suspect unwinding and settling the trade is not an entirely clean transaction.

Looking at expiration data and the following trading session there is an awful lot of play and back room steam rolling going on.

Overall, you've got a Good Arb Idea, Develop it and propser... good luck

 

[iuykcif]

Hello toswilliam,

I am relatively incompetent about options. Anyway I can express a concept which you may probably translate in your strategic world.

Based on my personal experience, in any strategy you use, whenever you introduce anything conceptually equivalent to a stop loss you won't go far. You will never break, in the long run, the 50/50 threshold to be profitable.

Clearly if anyone has contrary examples I'll be happy to be confuted.

The point is that one should be able to find alternative way to control risk. The 0/1 doesn't work, unless against you.

I am saying probably about the same thing Tradator said. Except I am making the point more general.

Quote from toswilliam:

Thanks for all the input. I am still testing the strategy and this month with the exception of the 31 where I was in and out of the trade 13 times x $7 comm on each full trade and a few missed ticks brought me to -$150.00 on the day. It has blown right past the naked short position and has maintained a very close hedge. I realize this could eat up alot of premium if it stays in the channel but in this case I will probably be 4 or 5 days without and risk on coming out of the futures contract. My thoughts are now that it would probably make more sense to sell the put and the call just out of the money to collect more premium on the front end so if I get caught in a few more days like the 31st it doesn't eat through the premiums collected.

There is more variation on the emini to the spy than I would like. I am also going to test on the futures options so price would directly coorelate and be a perfect hedge. Less slippage.

It is alot of work and possibly alot of commisions but I am looking to hedge as close to 100% of my trade as possible and just collect the time decay. At current volitility selling the call and put just out of the money you would collect 2.50 on each side. $2,500 in premium even if I spend $1000.00 protecting the position after taxes I am still making 5% on the trade.

 

[mushinseeker]

Just like I said before - you are neg gamma scalping since you are naked puts hedged with some underlying. Furthermore doing it 1-1 i.e. S 5 puts vs L 1 emini could be hard to handle as far as risk / PnL predicatability since your put deltas would probably not be -100x5 vs. 1 emin. Depending on days till expiration and strike distance your naked put delta might only be +350 vs.short 500 spy stock(1 emini). Deltas bleed higher /lower depending on IV and DTE and dist to strike.

 

[jones247]

Good point,

whether one implements a gamma scalp or a reverse gamma scalp (which in essence is what's being described in this thread), it's all about being aligned to IV. If you think IV will drop after the trade, then reverse gamma scalp. Otherwise, a gamm scalp is best if IV is expected to rise after the trade.

One other thing... if you expect a price breakout, then gamma scalp; however, if you expect price to remain within the needed channel for the trade to be profitable, then reverse gamma scalp.

Personally, I was more of a proponent of gamma scalping than reverse gamma scalping; however, upon further consideration, depending upon market volatility... I'm starting to reconsider.

Thanks for the "food for thought" toswilliam.

Walt

Quote from MushinSeeker:

Just like I said before - you are neg gamma scalping since you are naked puts hedged with some underlying. Furthermore doing it 1-1 i.e. S 5 puts vs L 1 emini could be hard to handle as far as risk / PnL predicatability since your put deltas would probably not be -100x5 vs. 1 emin. Depending on days till expiration and strike distance your naked put delta might only be +350 vs.short 500 spy stock(1 emini). Deltas bleed higher /lower depending on IV and DTE and dist to strike.

 

[jones247]

In consideration of a reverse gamma play, I would enter a front month short straddle (or no more than 6 weeks to expiration). As the market moves against me, at the point of breakeven relative to the premium on received on the leg that's now at a loss, I would short/long the underlying to be delta neutral. If the market then retraces, I would sell another straddle at the original entry point. However, I would probably need to close the original short straddle & open position of the underlying, otherwise the underlying can continue to move aggressively against me.

So on & so forth... until expiration...

The bigger challenges are rise in IV, the price reversing strongly in the opposite direction, increased margin requirements, transaction cost (especially for the options) & slippage...

Unless I'm overlooking something, if you can overcome these obstacles, then this could be a profitable strategy... However, like any option strategy, timing of use is critical...

 

[jones247]

Then again... K.I.S.S. - simply enter a short straddle & cover when you achieve a 10% return on margin or when the the premium to cover your loosing position equals the sum total of premiums received.

Just do this with a European Style Index Option...

 

[oraclewizard77]

If you live in USA, can you still trade European style index option on the es or if not what instrument would you trade, and could you give example of the actual symbols for this version?

The other way I could see doing this would be to analyse the market, and decide if it will go up down before expiration. For example, you think the market will keep going up, you sell an out of the money put. You also watch either stoch or MA. So instead of say going short the es future once it directly violates your line in the sand, you go short on the crossover, and then get out of the short if it crosses back. You would also need look at time frames. The main goal would be being hopefully right in the 1st place more than 50% of the time, and not need to initiate the hedge. The hedge would be put on only during normal hours. With some luck, you could also have the market move in your direction over night instead of moving against you. For example, you sold es at 1030 during the day to protect your 1031 long call. The market falls to 1020, you get out of the es trade with profit, and your option was protected the entire way. However, the market overnight goes back up to 1035. At this point you already made profit for the month and could close the trade, and take the rest of the month off, or just wait till the option expires worthless and collect double the money. Obviously, you can have the reverse happen, where overnight messes you up.

Quote from jones247:

Then again... K.I.S.S. - simply enter a short straddle & cover when you achieve a 10% return on margin or when the the premium to cover your loosing position equals the sum total of premiums received.

Just do this with a European Style Index Option...