The Beauty of Options - Portfolio Insurance at a Discount

[VolSkewTrader]

"The trades are negative theta, but the options models are incorrect on the negative theta calculations on far out of the money options."

The theta bill on your far-out puts doesn't take into account that the put strike skew steepens over time. So your long winger puts move incrementally higher in IV all else being equal. The theta reading on your long puts is theoretically correct, but negated by the upward drift in their IVs due to the vol smile gradually steepening over time.

 

[ironchef]

A portfolio insurance is basically a risk covering strategy that helps you to avoid losses or cut them in a way where you can sell your trading options at a decided price in near future.However, you need to pay a certain premium for the same.

It is not portfolio insurance.

 

[Sweet Bobby]

It is not portfolio insurance.

Correct, this is an overall income strategy that sends Sweet Bobby’s kids to college when the market crashes!

 

[ironchef]

Correct, this is an overall income strategy that sends Sweet Bobby’s kids to college when the market crashes!

You got paid only when the market crashes, otherwise, no cigar, no tuitions for kids?

 

[shh]

In general you want a low vol regime...like a sub-12% VIX environment, and where the upside call IVs are trading in the single digits (irrationally cheap). You also want a relatively steep skew, which normally is the case in a low vol environment, where the upside calls are trading at a significant (both historically and statistically) discount to the ATM and the rest of the smile. I wouldn't do the call ratios in anything less than 30 DTE. You want the upside vega as well as the gamma on the rally, while the skew will work in your favor on the break.

You also want to make money on any direction the underlying market (index) goes. So doing the call ratio delta neutral (e.g. sell 1 40 Delta calls & buy 2 20 Delta calls, or sell 1 45d call & buy 3 15d calls) is best practice. You can do it in any ratio combination: 1x2, 2x3, 1x3, etc.), buying more of the wings the steeper the curve and the lower the overall IV.

In the end you're hoping for a breakout rally and vol to stop creeping in (VIX bottoming) as your upside call IVs will have nowhere to go but up. But you'll take a market crash too as you'll benefit from a small long gamma & vega position, and make really good money on the call skew flattening out.

Thanks for your thorough explanation.
For the call ratios that you described, is it also good to partially delta hedge them with futures?

 

[shh]

Hello ffs,

Would you believe that I've never had anyone ask as nicely as you to share a little more details. Because of your kindness, here it goes.

I maintain a golden ratio of 0.6 short puts to long puts or lower. Currently, I have 57 short puts and 130 longs. My total "cost" of all these puts combined is $1,606.26. I go way out in time and sell 3 puts, while simultaneously buying 5 puts, 50 points below my shorts, but in a shorter time period. I usually accomplish this entire trade at breakeven or a small credit. If I have to pay a debit, I don't put on the trade. You would be amazed at how often I can find these spreads for a credit.

Then, I place a GTC order in the same expiration as my shorts to buy an additional 5 long puts, at a price much less than what I received in credit from the shorts. If the market moves up, I ultimately get a better price on my longs. If the market crashes, I hit the lottery. As time goes on, I will close my short puts as they get nearer to expiration.

The trades are negative theta, but the options models are incorrect on the negative theta calculations on far out of the money options. But, I do get a little positive theta because I sell short income puts (anywhere between 5 and 10 delta) at about 60 days out in time. I only sell as many puts as I can justify by making sure I don't have significant risks on the thinkorswim analyze tab. I also can place a few long calendar spreads in areas where my t0 line starts to sag.

With the big run up in the markets yesterday, all of my short income puts closed for profits! I will not place any new short puts on until we get a good down day in the market. Now, let me show you the price slices of the current portfolio. View attachment 231388 So, this is my current hedge with zero short income puts. Notice that there's nowhere on the board that I lose money. Admittedly, if the market goes up 15% I'm only making $300 or so bucks. If the market tanks 20%, I'm only making $3,400. But, the downside does NOT take into account the increase in volatility. So, let's look at what happens with a 20% drop in the market with a modest increase in volatility. View attachment 231390 View attachment 231388
View attachment 231390

Well I'll be damned! Look at that! And, please consider I've already hit the downside jackpot twice this year. Take a little of those funds and put it in real estate, etc. Then, start building another hedge trade. And this hedge is a perfect compliment to my other investments, 401k, IRA's. Not a bad little hedge factory that I have going on here, huh?

Anyway, I hope I answered some of your questions. If you need any more specifics, just let me know.

Sweet Bobby

Thanks for openly sharing. I myself am a beginner, that's why I did not directly comment on your strategy. I wanted people with more experience to break down your approach and verify that your logic flows. Thanks for sharing man. Anyway , you are the reason this productive thread started and we got the opportunity to ask our questions as we attempt to dissect your structure.

 

[destriero]

"The trades are negative theta, but the options models are incorrect on the negative theta calculations on far out of the money options."

The theta bill on your far-out puts doesn't take into account that the put strike skew steepens over time. So your long winger puts move incrementally higher in IV all else being equal. The theta reading on your long puts is theoretically correct, but negated by the upward drift in their IVs due to the vol smile gradually steepening over time.

Yeah, the guy is clueless.

 

[shh]

Yeah, the guy is clueless.

So, he does bleed theta (as anticipated by the model)on those near expiry long puts, yet the IV steepening (elevation of IV on the OTM puts) partially helps him?

 

[VolSkewTrader]

Yeah, the guy is clueless.

Sometimes being stupid and lucky isn't a bad way to go through life.

 

[destriero]

So, he does bleed theta (as anticipated by the model)on those near expiry long puts, yet the IV steepening (elevation of IV on the OTM puts) partially helps him?

He's short the diagonal. I don't want to waste time on this idiot, but yeah, he's wrong.