Synthetic Vs. Underlying Hedge

[nodelta]

Hello all.

I was thinking of a synthetic long hedge and wanted some feedback.

In a skewed market like the YM or ES, would it be better to get some long exposure by selling a slightly OTM put and buying a slightly OTM call for a synthetic long adjustment?

You'd be selling expensive vol and buying cheap.

Seems the skew would give you a bit of a statistical edge if the market moves up vs. just hedging with the long underlying.

ND

 

[riskarb]

Quote from nodelta:

Hello all.

I was thinking of a synthetic long hedge and wanted some feedback.

In a skewed market like the YM or ES, would it be better to get some long exposure by selling a slightly OTM put and buying a slightly OTM call for a synthetic long adjustment?

You'd be selling expensive vol and buying cheap.

Seems the skew would give you a bit of a statistical edge if the market moves up vs. just hedging with the long underlying.

ND

It's a risk-reversal with skew edge. The volty-drift will actually help a bit -- your short puts will become "more" otm(higher volty) and your calls *should* gain a bit(or not lose) volty due to the volty-drift as well.

Caveat: there is linear-risk; nearly that of simply going long stock, but there is certainly edge there.

riskarb

 

[vega]

Quote from riskarb:

It's a risk-reversal with skew edge. The volty-drift will actually help a bit -- your short puts will become "more" otm(higher volty) and your calls *should* gain a bit(or not lose) volty due to the volty-drift as well.

Caveat: there is linear-risk; nearly that of simply going long stock, but there is certainly edge there.

riskarb

That's how our guys (MMs in the SPX at CBOE) used to make all of their money. Sell paper the put they HAD to have, buy some out of the money calls at cheaper vol to help deal with the negative gamma from selling the puts, put the extra premium in the bank, manage the risk, and call it a day

Vega

 

[GATrader]

Hi vega. You said used to.. why not now. The skew seems to be present still in most of the stocks? Thanks

 

[vega]

Left the floor 2 years ago, and to be honest haven't paid that close of attention to the SPX in terms of vol and skew. I assume that this is still the prime money maker for the MMs, just haven't been there in a while so I said "used to." Hope that answers your questions.

Later,

Vega

 

[riskarb]

Quote from vega:

That's how our guys (MMs in the SPX at CBOE) used to make all of their money. Sell paper the put they HAD to have, buy some out of the money calls at cheaper vol to help deal with the negative gamma from selling the puts, put the extra premium in the bank, manage the risk, and call it a day

Vega

Amen, brother. Just need to sell those futs-delta a bit soft.

riskarb