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Protection against catastrophy
- Thread starter hlpsg
- Start date
Quote from dagnyt:
What you want is front-month strangles, not back month options. Theta is not an issue here. You want, need, + gamma (at much lower market prices).
To guard against a catastrophe, buy some FOTM options at prices that do not cost a lot of dollars.
Obviously if you want protection against a 5% decline, that is an entirely different story.
Mark
Hi dagnyt,
Thanks for the input. I've tried FOTM front months and their hedging power decreases dramatically with time. If a huge gap happened closer to expiry, it might not cut my losses by much I think.
I might be mistaken, but by using back months, since there's a lot of extrinsic left, a huge jump in IVs will really bump up the downside curve.
I'm mostly protecting for a more reasonable catastrophe (having a higher likelihood of happening I guess) of perhaps a 10 - 20% gap down in price, and these FOTM options don't help much in these situations?
Thanks again, and if I'm mistaken in any of my points, feel free to correct me.
Quote from jj90:
Short answer: backspread.
Thanks. That's something I did think of but unfortunately the max loss curve of the backspread lands exactly where it's most probably for the underlying to end up should there be a huge gap down.
I'm not very familiar with trading backspreads so again, pls feel free to correct me. They are an interesting idea for sure.
I was thinking if there was possibly a feasible way to scalp movements in the underlying with my disaster hedge (e.g. the backspread) if I'm not doing very many contracts of the protection itself? My experience looking into gamma scalping techniques in the past came up with the conclusion that you needed a really huge portfolio to be able to scalp gammas efficiently.
Quote from spindr0:
One thing that wasn't in your list was to be in bearish as well as bullish strategies. That way, your potential catastrophe has some benefits as well.
Hi spindr0, thanks for the tip. Would you mind giving an example of this, and how you would manage them? How much of your portfolio would you dedicate to trading these bullish/bearish strategies?
Thanks.
If you do a mix of bullish and bearish spreads, what happens if the market tanks? The bearish spreads could possibly be 100% profitable and you'd only have problems with the bullish spreads. If the market range traded, you might do decently on both sides.Quote from hlpsg:
Hi spindr0, thanks for the tip. Would you mind giving an example of this, and how you would manage them? How much of your portfolio would you dedicate to trading these bullish/bearish strategies?
Take mid 2007 when the market started declining. Suppose you're into equities and you have a mix of bullish and bearish spreads. Suppose your bearish spreads are expiring each month but your bullish spreads don't. Isn't that a bit of a hint that your bias should be shifting to more bearish?
If you're dealing with individual equities, anything is possible since they don't always move in tandem with the market. But if they're indexes, they will, which is why some trade iron condors - it's unlikely that you'll lose on both sides.
Quote from hlpsg:
hello, I'm looking for ideas/books on methods to protect a basically short gamma portfolio from catastrophic events.
I am defining such an event as one where you will not be able to place any orders of any kind. I'll assume the exchanges will all be down, or forced to close for a period of time.
Thus any kind of hedge will have to be static I think, and already in place whenever you have captial at risk.
Some ideas I've thought of to manage losses during such catastrophic events:
1) Back month strangles for protection. Downside - very expensive to buy an effective hedge. Hedging power decreases with time also.
2) Money management. Control the amount of capital at risk.
Downside - expensive in the way that returns are cut drastically.
3) Do not get too close to expiration, before gamma gets very negative.
Downside - miss out when theta is greatest.
Will appreciate any ideas or recommendations to books I can check out. Thanks.
You didn't mention a specific short gamma trade--for simplicity I will assume you are short either calls or puts. I have used the following:
1. I only place OTM bull put spreads or OTM bear calls spreads instead of naked puts and calls or straddles and strangles.
2. I only place enough positions so that my margin requirements are less than half my account equity.
3. I have also placed bear put spreads with my bull put spreads(OTM and a wider spread than most) for more insurance; placed bull call spreads with my bear call spreads as well.
4. I try to let the short, OTM options expire and exit the longs on the day of expiration or the day before (margin permitting). Obviously, less risk and smaller profits. Hope this helps.