Replication question

[phattails]

Let's say I'm trading a breakout strategy. If I only trade the underlying, I pay commissions everytime I get whipsawed. If I buy a straddle, then I have to pay premium on volatility that's most likely expensive. Is there an options hedging strategy that benefits from a breakout yet is cheaper than affording commissions and slippage on flipping positions ? Or is all of this completely dependent upon one's view of future volatiliy, price movement and commission structure? I appreciate any constructive feedback and engaging counter questions.

Thanks!

 

[globalarbtrader]

Let's say I'm trading a breakout strategy. If I only trade the underlying, I pay commissions everytime I get whipsawed. If I buy a straddle, then I have to pay premium on volatility that's most likely expensive. Is there an options hedging strategy that benefits from a breakout yet is cheaper than affording commissions and slippage on flipping positions ? Or is all of this completely dependent upon one's view of future volatiliy, price movement and commission structure? I appreciate any constructive feedback and engaging counter questions.

Thanks!

Buy a strangle with strikes where you expect the breakout to happen.

Having said that it's my experience that the extra cost of buying implied vol through strangles and straddles, rather than buying it synthetically by trading the underling, is far higher than commissions unless your breakout range is very narrow so you end up trading very frequently.

GAT

 

[phattails]

Buy a strangle with strikes where you expect the breakout to happen.

Having said that it's my experience that the extra cost of buying implied vol through strangles and straddles, rather than buying it synthetically by trading the underling, is far higher than commissions unless your breakout range is very narrow so you end up trading very frequently.

GAT

Yes, I agree to an extent. How do the costs compare when you've flipped the trade 5 times though. Buying options might be more expensive in the beginiing, but I'm talking about E[costs]I.I have a feeling there's a way to hedge something like this without directly doing so. It might involve different expirations, but I won't have time to research this for 3 weeks.

 

[JackRab]

I find that when you get whipsawed a lot, you're putting stops to close to entry...
Move them further away, depending on your expected exit when breakout actually occurs...

The good thing with a straddle, is that the decay might be slower than any whipsaw trading, but on the other hand, your starting delta is 0... so it takes a while before it kicks in.

 

[globalarbtrader]

Yes, I agree to an extent. How do the costs compare when you've flipped the trade 5 times though. Buying options might be more expensive in the beginiing, but I'm talking about E[costs]I.I have a feeling there's a way to hedge something like this without directly doing so. It might involve different expirations, but I won't have time to research this for 3 weeks.

Well if you think you can predict when the breakout will occur then that will govern your choice of expiry. If you don't know when it will occur then you'll have to buy a longer dated option that will cost more.

Ultimately if you think you might be wrong on the trade then the downside is limited with options (a much bigger downside by the way comes from the actual buying and selling on each whipsaw; that will dwarf what you pay in commissions). You have to pay up for that certainty.

GAT

 

[phattails]

I find that when you get whipsawed a lot, you're putting stops to close to entry...
Move them further away, depending on your expected exit when breakout actually occurs...

The good thing with a straddle, is that the decay might be slower than any whipsaw trading, but on the other hand, your starting delta is 0... so it takes a while before it kicks in.

.

Yes but theta kicks in. The whipsawed thing wasn't meant to be illustrated as a problem. Certainly there is a minimum Delta which is outside of noise and an expected movement per trade. What I'm talking about is an option position that pays for the cost of flipping and how to structure it.

 

[phattails]

Another way to ask this is, what's the cost to replicate a double barrier option and a rebate option.

 

[JackRab]

An option position that pays for your losses+commision on negative flipping... hmm...
Well, that initially sounds like a short straddle... but you will not get anything when a breakout happens.

I don't get it... you say whipsawing isn't the problem...? You can't have it both ways... even with a knock-in barrier option you pay premiums which have time decay.

Look, it depends as well on how far from current spot the break out might happen, then you could by a further OTM option, which will have a lower premium. But there's no free lunch...