VIX - Ratio spread. Short 1x 9 call, long 2x 10 call as a hedge positions for .45 debit
I f'ing nailed it!
Unfortunately, I closed this on Tuesday for reasons that make me sick to my stomach to think about in retrospect and I won't repeat here.
Lesson learned. Time to be happy this was a test size account, and not live (excuse the contrivance). I will never again leave this strategy without a hedge.
But the story here is the VIX ratio spread is exactly the exposure I need to protect against the black swan event. And my position size was actually larger than it needed to be (so much so, it would have covered my investment losses of the last two days too). So this is a very cost effective method of protecting against surprise downward gaps. My open position here were equal to 120 units (this is just my position sizing tool)--relatively equally weighted, and the cost to hedge this is around 6-10 units, with some expected recovery on close.
Going forward, the way to play this one for a 100 unit account is to have the ratio spread open in the amount of 2.5 units for 45-day expiry, and 2.5 units for 75-day. Close them 15 days prior to expiry, and rolled out to the 75-day. This would be the mid-month expiration, purchased and sold on the first day of the month. And, in the event that we're high on the VIX when it comes time to roll, it would need some short term coverage while we get back down under 10 or 11. The total cost of this should be somewhere in the neighborhood of 3-4% for the 90-day life of the diagonal strategy.
The close orders on that are clear, the rest an order to recover 12.5% and 17.5% of account value on the near-term VIX ratio, and 22.5% and 27.5% on the far-term, and we're 80% recovered. (I need to double check these numbers). Beyond that, hold and hope is the goal for the remaining 20% outstanding, which shouldn't be a problem on options that go out past the next earnings date.
No, we move on to the slightly more difficult hedge on this, the move upward that closes the absolute spread of the diagonal (i.e. if I have a 90-day $55 long, and a 10-day $50 short, the absolute spread is $5 x number of contracts less the credit). This can actually get pretty large if the early move is against the long side of the diagonal.
Credit spreads are not an option here because what I pay for the long side tips the scales against me for the diagonal overall. I can pick up some of the exposure by doing basically a reverse ratio spread, where I long half-size, but that brings that tips the scales even. I've considered leaving these open too, presuming the extrinsic gain on the top side will help some, but the problem is, the volatility loss if it goes up. Systemic hedging (i.e. using the SPX / SPY) doesn't work either because I'm more concerned with individual moves on position I hold.
Stops do provide substantial protection on these positions, but only for intra-day moves--which the up sides tend to be. But that still leaves me exposed to good news pushing the stock up sooner than I intended.
So, it's that absolute spread that I need to figure out the best way to hedge before this one is ready to go live...the answer may in fact just be to hedge with the spread itself, and only short a fraction of the long-side's contracts to keep the absolute exposure to about 120% of my target exposure (the assumption being that the increased extrinsic value on the long side will offset the additional exposure in a move)...
So, stuff to think about.
Also eyeing the 8/18 MSFT 72.50 and 73 calls to short against my position....I'll wait and see on this by the end of day here because there's more noise than I'm comfortable with. But my charts are showing continued bearishness likely for the 1-2 week time frame. Not sure how much of that is noise from the North Korea news--I wouldn't want to be left holding the bag when this is resolved and this flips to a full-on bull.
