Using options for hedging purposes

T

Tomaz26

Hello,


I want to start using options to hedge my mostly stock portfolio positions. Is it a good way or too expensive? I know now that volatility has risen it became expensive but how about buying hedge after a long up-run? I do not wish to speculate when drop will come so selling my portfolio is not an option. I just want some insurance which I could sell if the price drops and just and re-buy it later if prices rise again etc.. I can see that after low vix values there are allways times when VIX shoots up and then again fell down etc. So how about strategy with buying insurance when vix is low and then selling it when vix is high. I know it could happen that VIX stays down for a long time but since I am long stocks at that time I would just loose some % of my portfolio on hedging on the other hand when prices drop 15-30 % I could lower my drop in portfolio with put options.

Now the question is how much time should I buy for hedging purposes and which strikes? Should I buy ATM, ITM, OTM, 3 month, 9 month ... I know last 30-60 days options are expensive beause of time decay so I guess those are not good for portfolio hedging.. Also how much should you risk for hedge? If hedge lowers your portfolio value by 3 % yearly this could be a problem.

Does anyone here use options for hedging purposes? Can you please explain how you choose strike prices and how much time you buy?

thans to all for help

Tomaz
 
Quote from Tomaz26:

I want to start using options to hedge my mostly stock portfolio positions. Is it a good way or too expensive?

Car and health insurance are a total waste of money until you need them. The size of your claim determines whether having that insurance was a good idea. Same deal with options.


Now the question is how much time should I buy for hedging purposes and which strikes? Should I buy ATM, ITM, OTM, 3 month, 9 month ... I know last 30-60 days options are expensive beause of time decay so I guess those are not good for portfolio hedging.. Also how much should you risk for hedge? If hedge lowers your portfolio value by 3 % yearly this could be a problem.

That's too big of a question to answer easily. Set up a spreadsheet with underlying and various options. Determine yield/cost if stock rises, does nothing, drops some, drops a lot.

Option chains can provide protection info in strike difference increments w/o regard to IV or the passage of time. IOW, stock at 100. Buy 95 put. If stock drops 10 pts, 95p is now 5 pts ITM. Right now, with the UL at 100, the 105p is 5 pts ITM so if stock dropped to 90, the 95p would also be 5 pts ITM so it be worth what the 105p is worth today. So maybe you'd have a 5+ pt gain on the put while losing 10 on the stock. Look at various month, various strikes. A bit tedious to look at a lot of these, eh?

To bring IV and time into the equation, you'll need a program that graphs P&L curves at various time periods.

To reduce the cost of the put insurance, consider collaring your positions (sell OTM CC to fund the pruchase of you protective put). Same analysis as above applies.

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Quote from Tomaz26:

If hedge lowers your portfolio value by 3 % yearly this could be a problem.


Tomaz [/B]
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not to be the bearer of bad news so early but if you're not willing to spend 3% protecting your port from catastrophic decline then just take the risk. see recs from above poster re collaring. insuring anything costs money, period. there is no way around it.
 
Thanks for suggestions. I found a very good paper testing different collars for QQQ from 1999 to 2010 with very good results. This strategy of course trails returns in bull market(returning 5-7 % yearly instead of 21 %) but really shines in nasdaq decline in 2000 and also very good returns from 2007-2010 ! For example in declining years you get +23 %. I must read the paper again in details because I am not sure how you can get so drasticaly better return in declining years. I though with collar you cannot earn much but you also cannot loose much. I think the strategy was buying 6 month puts and monthly selling 1 month out calls. All in all you get more than 1/2 lower volatility with nice yearly returns. I think now after such spectacular run-up in 2 years it is time for this strategy. I guess the only time not to hedge like that is after 50+ % sell-offs after recessions etc.

thanks
 
Quote from Tomaz26:I can see that after low vix values there are allways times when VIX shoots up and then again fell down etc.

Does anyone here use options for hedging purposes? Can you please explain how you choose strike prices and how much time you buy?

Good recommendations on the collars.

I just wanted to add a couple different options.

I'm going to assume that you've calculated a beta-weight on your portfolio so you have a pretty good idea of your exposure vis-a-vis broad market movement and you're using a corresponding value in SPY as a portfolio proxy.

In periods of high volatility, spread trades are your best bet to minimize the increased cost of protection due to increased volatility.

Depending on your mid-term market outlook, you have two choices for the hedge. If you think downside risk is only going to last a short time, enter an ATM-OTM vertical put spread. This decreases the debit for the ATM put, hedges I-vol, and mutes theta decay.

Example: Long SPY Sep 120p, Short Sep 112p. Total debit 1.96 (1.63%)

If you feel downside risk is going to last a more than a month, enter a diagonal put spread, with the long leg three to four months out. Sell the OTM weeklies at your short-term downside target and roll the short leg each week (with an updated downside target).

Example: Long SPY Dec 120p, Short Sep 2 115p. Total debit 6.73

If you can generate .33 in premium for the short calls each week, you can reduce your cost basis down to about 2.00% at Dec expiration, and you'll have had the protection for three months.
You can always ratio the spread to give you more downside protection by shorting fewer calls than you are long. Or if things get really ugly, just buy to close the short calls and have complete downside protection.

If the market begins to show strength, the long-dated put can be sold to close with an excellent percentage of extrinsic value.

Quote from Tomaz26:So how about strategy with buying insurance when vix is low and then selling it when vix is high.

My colleagues and I will play VIX long when it gets below 20 for extended periods of time, usually through VXX. We'll go long ATM or slightly ITM calls four to six months out and then sell OTM front month calls against the position, usually in a ratio.
As a personal preference, we don't play VIX short. This is just treated as an entirely separate position and not as a portfolio hedge. I wouldn't recommend trying to hedge an entire portfolio using VXX.
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Is there a fundamental benefit to heding an option position vs. closing out the option, assuming the hedged position will remain intact through expiration?

any thoughts...

thanks,

Walter
 
convexity

Quote from jones247:

Is there a fundamental benefit to heding an option position vs. closing out the option, assuming the hedged position will remain intact through expiration?

any thoughts...

thanks,

Walter
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thanks for the reply...

...but I would imagine that if the hedged position is being held to expiration, then only pin risk would be of concern. However, I don't see why convexity/gamma would matter if I'm holding both the long & short option 'til expiration.
 
Think I misunderstood you. Same option?

Quote from jones247:

thanks for the reply...

...but I would imagine that if the hedged position is being held to expiration, then only pin risk would be of concern. However, I don't see why convexity/gamma would matter if I'm holding both the long
& short option 'til expiration.
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Quote from Tomaz26:

Thanks for suggestions. I found a very good paper testing different collars for QQQ from 1999 to 2010 with very good results. This strategy of course trails returns in bull market(returning 5-7 % yearly instead of 21 %) but really shines in nasdaq decline in 2000 and also very good returns from 2007-2010 ! For example in declining years you get +23 %. I must read the paper again in details because I am not sure how you can get so drasticaly better return in declining years. I though with collar you cannot earn much but you also cannot loose much. I think the strategy was buying 6 month puts and monthly selling 1 month out calls.
More...
A same month collar is equiv to a vertical spread. Using different months makes it a diagonal. Either way, you're not going to make +23% in a down market with long stock/index collars unless there's one or more of the following: legging in, ratioing, adjusting, and getting a favorable bounce.

Somewhere I ran across an article about dealing with crashing collars. Their suggestion was to book the put gain at expiration, buy more shares with those proceeds and do a correspondingly larger number of new collars at the lower stock price. It's a losing proposition until the stock eventually rallies and then you cash out when assigned at the short call strike with a net profit. Essentially you're dollar cost averaging with your own money (the put gain) and eventually taking the last spread's maximum gain. If the UL never bounces, you're dead meat :)
 
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