Out of the money vega question

[hardtofin]

Hi guys,

If bought lots of OTM puts in the FTSE a couple of weeks ago paying only pennies. These have now really risen in value with the indices falls og the last few days so I have accrued a very large vega position on them.

Because i trade an overall "book" of options, i cannot simply sell them as i have sold against them at higher strikes, although not in equal measure, so i have a ratio spread of sorts and i need them as a hedge.

My question is two fold. Firstly:

1) How do i now neutralise my vega effectively. I am worried about the underlying staying here for a few days and the IV coming down, therefore crushing these puts. I cant just sell straddles or vol endlessly until my vega is neutral as it would require a colossal amount of margin.

2) . How is it best to manage vega at different (and especially) OTM strikes overall. The market can be trading at X on one day, you buy lots of cheap gamma OTM, either calls or puts, and then the underlying moves sharply meaning the once OTM options with no vega are now ATM and have huge vega, however, you know that should the underlying move back again, you will lose that vega. It seems a bit like having a high tide that recedes and I have always struggled to properly manage it.

Any help anyone can give i would be sincerely grateful.

hardtofin

 

[Martinghoul]

To be sure, these are short-dated puts, right?

 

[hardtofin]

To be sure, these are short-dated puts, right?

Sorry, yes they are. They expire in 4 weeks. My raw net vega is pretty flat, but once i adjust it to time weighted vega (which is the measure i use), i am carrying a lot of vega. I should have mentioned that also.

 

[Martinghoul]

I dunno if there is really anything too creative that you can do. If your position is too large in some particular aspect, the best thing to do is to reduce it, rather than attempting some clever offsets, IMHO. This is especially true if you’re constrained in terms of the amount of leverage/margin you are willing to deploy.

 

[hardtofin]

I dunno if there is really anything too creative that you can do. If your position is too large in some particular aspect, the best thing to do is to reduce it, rather than attempting some clever offsets, IMHO. This is especially true if you’re constrained in terms of the amount of leverage/margin you are willing to deploy.

Yeh, this is kind of what i thought. I have tried previously to hedge it by adding long delta, so that when the underlying rises, the positive delta offsets the vega crush, however, the last time i did this was on a Friday, the underlying didn't move at all on the Monday morning, however the vol got crushed and i got hit as the long delta didn't do anything as it needed an underlying move.

If the underlying had gone lower, although long delta, the bigger long vega position would have hedged me as the gain from the increasing vega would have offset the long delta loss.

So it seems, i can either use long delta to hedge the long vega but have to take a view the underlying will rise, and if i don't think the underlying will rise, i somewhere have to sell enough vega to flatten my vega totally.

But is there a better solution to hedging OTM vega, i.e options you buy that are OTM and have little to no vega, that when the underlying moves, suddenly explode with vega?

 

[Martinghoul]

Yeh, this is kind of what i thought. I have tried previously to hedge it by adding long delta, so that when the underlying rises, the positive delta offsets the vega crush, however, the last time i did this was on a Friday, the underlying didn't move at all on the Monday morning, however the vol got crushed and i got hit as the long delta didn't do anything as it needed an underlying move.

If the underlying had gone lower, although long delta, the bigger long vega position would have hedged me as the gain from the increasing vega would have offset the long delta loss.

So it seems, i can either use long delta to hedge the long vega but have to take a view the underlying will rise, and if i don't think the underlying will rise, i somewhere have to sell enough vega to flatten my vega totally.

But is there a better solution to hedging OTM vega, i.e options you buy that are OTM and have little to no vega, that when the underlying moves, suddenly explode with vega?

Yeah, so, as you said, you could try to get clever about it and try to come up with an offsetting position, which may, or may not, be a hedge, depending on whether the correlation you're expecting actually materializes. However, obviously, this, in itself, becomes a trade and carries risk, which might not be what you want when your goal is actually to reduce risk.

As to getting into risk that you didn't have, look at it this way. It's sort of a "first world" problem, isn't it? You've acquired this exposure, because you were the right way around. Taking some profit isn't such a terrible thing, however you choose to engineer that (you could reduce or maybe restrike).

 

[Darkiana]

Isn't an occasion to use VFTSE futures (if they exist, if not use V2X futures as a proxy)? Sell futs with same maturity as your options. Or sell them as a spread against longer maturity futs (to limit backwardation effect).

 

[Martinghoul]

Isn't an occasion to use VFTSE futures (if they exist, if not use V2X futures as a proxy)? Sell futs with same maturity as your options. Or sell them as a spread against longer maturity futs (to limit backwardation effect).

I don’t think there’s a liquid ‘FTSE VIX’ mkt out there...

 

[hardtofin]

I don’t think there’s a liquid ‘FTSE VIX’ mkt out there...

There's not, i usually sell straddles to sell vol. But i don't want to sell too many because it affects my gamma once i go out of the range of the credit of the straddle.

 

[kj5159]

If you're using these puts as a hedge, then you're probably not necessarily trying to profit by having them but rather avoid a loss, yes? If so leave them alone. I don't know anything about your overall strategy but what about reducing/taking off the other side of the the trade so you can take profit on the puts? I presume you might be using the index puts to hedge a more diverse group of holdings on the other end so that may not be directly feasible but food for thought. You gotta choose.