Selling OTM (not deep) and buying units to hedge

J

jtunner

Could an experienced options trade comment on the following strategy:

- Selling OTM PUTs (but not deep OTM units) on SPX/SPY for a credit
- Buying deep OTM units (teenies) to hedge against a large and sudden move in the SP500 that one cannot react to, ie. adjust the short Put positions.

In other words, rather than selling deep OTM options with a lot of leverage one sells OTM options closer to the money with slightly higher delta for more premium and use some of this premium to buy unit Puts with low deltas that increase in value during sharp moves down (more than models predict). The short Puts would have to be rolled in response to a slower/orderly move down, while the long, deep OTM puts hedge the short Puts at times when markets moves to fast and become to illiquid for adjustments/rolling.

Has anybody had success with this kind of strategy (as opposed to just selling deep OTM)?
 
You need to buy more far OTM puts than the near term you short (in number of contracts, assume same maturity) to also profit from black swan events, otherwise it's just a spread and the far put just caps your losses. Play around with a maturity date payoff graph to see what option "combos" you can build to get the payoff you desire.

Careful about slippage and comm when many legs are involved. Study these costs in perspective of potential profits.

Also far downside options are (overly?) expensive (volatility smirks in eq indices) because everyone wants to profit/hedge against black swans, so there won't be much credit overall i think.
 
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