Vega trading. If you wanna be long volatiltiy you would buy an option, sell delta number of shares. Volatility increases, your option would be worth more, while at the same time your short position would remain the same. hence, you would make a profit. This is just one example.. Obvoiusly You would rather buy something with lower gamma.. meaning a options of a longer date..
Vega trading
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jimmyjazz ......... Don't drink the "option greek kool-aid" that is being served on ET.
I have posted it before and I will post it again. You don't need the option greeks to VISUALIZE THE TRADE, in fact the greeks are creating a fog preventing you from VISUALIZING THE TRADE. The AAPL option position is neutral to slightly bullish. Shorting AAPL is a bearish play, it conflicts with the neutral/slightly bullish Put Credit Spread.
All you need to VISUALIZE THE TRADE is the stock, your views on that stock, options strike and expiry, current quotes, pen and paper. I highly recommend you put those option greek tools away.
It's just trading volatilty.. It's not something you can isolate completely.. There are other risk you are taking.. And yes you can trade options as simply as you would like.. the option greeks are not cool aid.. They are derived to better dimension reality as flawed as they are.. all models are flawed.. One should read about black scholes if one is interested.. If not don't..
In the right hands I'm sure option greeks are useful, such as MM's to price them, but on ET they have limited if any use. jimmyjazz is a good example of what happens when someone focuses primarily on the greeks, he can't see the forest through the trees.
Sometimes people that completely subscribe to efficient markets and random walks believe there is no way to make money buy or selling options.. just as if a market maker hedging sold or bought options would never be able to profit from anything other then lower then customer transaction costs.. A bought option might end up representing very closely the realized volatility of the underlying yet because of the one way direction of prices might be a very profitable position.
This might be the issue some have with the greeks - that risk graph is a static snapshot of the position, right now.
To your point, you would only neutralize delta if you wanted to isolate your vega PL - that's the benefit of shorting 11 AAPL, it removes delta exposure at that point in time. From there your risk looks unlimited to the upside (and would be if you never re-balanced), but as AAPL moves up you would buy back the shorts as the delta from the bull spread would decrease...you would re-balance at some interval to remain delta neutral.
As you pointed out though, that bull spread doesn't carry a lot of vega so the PL won't really be driven by changes in vega. If you wanted to trade vega an atm straddle with a longer time to expiration would probably be better suited.
You have no idea what my focus is, and I'd kindly discourage you from speculating on such. You're all noise and no signal -- we get it, you don't understand simple calculus, so in your mind it's useless. That isn't the story for everyone. We all have our crosses to bear(ish).
Yes, you are absolutely right. By shorting 11 shares you are locally flat. It is the convexity of options that results in your delta changing (due to time passing, changes in implied vol, and movement of the underlying). So yes, good eye, from a global perspective your position looks a lot like a short and you would definitely be burned if it gapped up. Try this though. Use an in-the-money put for your delta hedge instead of stock. Your downside will look much better. I try to never hedge short gamma with hard deltas. You end up getting burned much worse in the opposing tail of the distribution.
So...quick answer. Yes, if you're a directional trader there is no need to be delta hedging.
Long answer... Delta hedging is a means to capture a perceived "arbitrage" in mispriced volatility.
Here is the way I always describe this style of trading to people. Think of a boulder sitting still at the top of a mountain. The boulder is displaying zero kinetic energy (it is currently stationary). But rather, it has POTENTIAL energy. Now say the boulder is displaced and begins tumbling down the mountain, the potential energy is now being converted into kinetic energy.
To extend the analogy, think of an option at time 0 at an implied volatility of 20% as the boulder. The implied volatility is the market's estimate of potential energy. Start the clock and let the underlying begin to move. The realized volatility can be thought of as the potential --> kinetic transformation.
The kicker is this. When the boulder tumbles down the hill, energy will bleed from the mountain/boulder system via sound, heat, etc. Not all of the potential energy will be converted to kinetic.
So what happens if the same is true of our option? Say you've sold at 20% IV, and been delta hedging. YOUR DELTA HEDGES ARE MEANT TO REPLICATE THE PAYOFF OF THE OPTION YOU SOLD. Let's say realized vol over the life of the option turns out to be 18%. The "bleed" was 2%. Where did that bleed go? In your pocket. The delta hedging payoff offsets the short option (which was overpriced) and you are left with the gravy as profit.
Now if that example didn't do it for you, here is another way to think about option pricing.....
Pretend you sold an ATM straddle. The underlying is at 100. You are short gamma. The stock ticks up to 100.50. Your short gamma has you accumulating negative deltas. You need to hedge, so you buy long deltas to offset. The stock then ticks down, but before you can react or place a new order, the stock has fallen below 100 to 99.70. Moreover, you've crossed the ATM line the other way. You're now losing on your original hedge and simultaneously accumulating positive deltas. So you have to flatten delta again, realizing a small loss on the original hedge in the process.
This keeps going, and going, and going.....The realized vol takes you back and forth across the risk-reversal line, and since "local time" is never zero (meaning quite simply that the underlying never stops at 100 and lets you rebalance at no cost then once you're all set starts moving again), you keep taking small losses. But as the time passes your short straddle is decaying to your benefit.
At expiry, if the option was correctly priced, the gains from the time decay equal and offset the sum of the small losses from dynamically trading the risk-reversal back and forth.
The caveats to this of course are all the usual, Black-Scholes world, problems with discrete hedging/path dependence, etc. Still the best way to learn and think about the reasoning behind delta hedging and "no-arbitrage" pricing. Hope this made some sense....perhaps...
So...quick answer. Yes, if you're a directional trader there is no need to be delta hedging.
Long answer... Delta hedging is a means to capture a perceived "arbitrage" in mispriced volatility.
Here is the way I always describe this style of trading to people. Think of a boulder sitting still at the top of a mountain. The boulder is displaying zero kinetic energy (it is currently stationary). But rather, it has POTENTIAL energy. Now say the boulder is displaced and begins tumbling down the mountain, the potential energy is now being converted into kinetic energy.
To extend the analogy, think of an option at time 0 at an implied volatility of 20% as the boulder. The implied volatility is the market's estimate of potential energy. Start the clock and let the underlying begin to move. The realized volatility can be thought of as the potential --> kinetic transformation.
The kicker is this. When the boulder tumbles down the hill, energy will bleed from the mountain/boulder system via sound, heat, etc. Not all of the potential energy will be converted to kinetic.
So what happens if the same is true of our option? Say you've sold at 20% IV, and been delta hedging. YOUR DELTA HEDGES ARE MEANT TO REPLICATE THE PAYOFF OF THE OPTION YOU SOLD. Let's say realized vol over the life of the option turns out to be 18%. The "bleed" was 2%. Where did that bleed go? In your pocket. The delta hedging payoff offsets the short option (which was overpriced) and you are left with the gravy as profit.
Now if that example didn't do it for you, here is another way to think about option pricing.....
Pretend you sold an ATM straddle. The underlying is at 100. You are short gamma. The stock ticks up to 100.50. Your short gamma has you accumulating negative deltas. You need to hedge, so you buy long deltas to offset. The stock then ticks down, but before you can react or place a new order, the stock has fallen below 100 to 99.70. Moreover, you've crossed the ATM line the other way. You're now losing on your original hedge and simultaneously accumulating positive deltas. So you have to flatten delta again, realizing a small loss on the original hedge in the process.
This keeps going, and going, and going.....The realized vol takes you back and forth across the risk-reversal line, and since "local time" is never zero (meaning quite simply that the underlying never stops at 100 and lets you rebalance at no cost then once you're all set starts moving again), you keep taking small losses. But as the time passes your short straddle is decaying to your benefit.
At expiry, if the option was correctly priced, the gains from the time decay equal and offset the sum of the small losses from dynamically trading the risk-reversal back and forth.
The caveats to this of course are all the usual, Black-Scholes world, problems with discrete hedging/path dependence, etc. Still the best way to learn and think about the reasoning behind delta hedging and "no-arbitrage" pricing. Hope this made some sense....perhaps...
Thanks. Why did you give the example of buying the 110, selling the 111, and delta hedging if you were non-committal on direction? In other words, why locally neutralize (delta hedge) a directional trade instead of just putting on a delta-neutral trade in the first place (straddle, strangle, calendar spread, etc.)? I get that you might end up having to modify THAT trade as time goes on, but at least not right from the jump.
By the way, I have made my career "trading" kinetic energy. Literally. I design flywheel energy storage systems for a living.
By the way, I have made my career "trading" kinetic energy. Literally. I design flywheel energy storage systems for a living.
I delta hedge precisely because I am non-committal on direction and am trying to realize the implied/realized vol spread. I DO NOT delta hedge to take a directional view. The important thing for you to understand is that when you trade delta neutral, puts and calls of the same strike are equivalent (via put-call parity....and do understand that there are some major caveats with American options). By delta hedging, I've hedged away the linear component of my risk. I'm now doing my best (via discrete hedging) to isolate convexity. If the vol is priced too rich, I sell options, delta hedge, and bank on my earned theta decay overpowering my cumulative losses from delta hedging a short gamma position. If the vol is cheap, I buy options, delta hedge, and bank on my cumulative gains from delta hedging overpowering my loss from theta decay.
So to be clear, it makes no difference whether I sell an ATM straddle struck at 100, or sell 2 calls struck at 100 and buy stock to zero delta. They are synthetically equivalent. When I'm delta neutral, puts and calls of the same strike are the same since they both have the same gamma.
The example of buying the 110, selling the 111 was just meant to give a simplified idea of basic vol arb. The key from that example was the relative difference in implied vol. Selling the higher priced 111 (in IV terms) and buying the cheaper 110 and delta hedging. Yes, I know stochastic vol/jump diffusions create IV smiles, but at a certain point, a large enough spread between two adjacent strikes begins to seem like a reasonable opportunity.
So to be clear, it makes no difference whether I sell an ATM straddle struck at 100, or sell 2 calls struck at 100 and buy stock to zero delta. They are synthetically equivalent. When I'm delta neutral, puts and calls of the same strike are the same since they both have the same gamma.
The example of buying the 110, selling the 111 was just meant to give a simplified idea of basic vol arb. The key from that example was the relative difference in implied vol. Selling the higher priced 111 (in IV terms) and buying the cheaper 110 and delta hedging. Yes, I know stochastic vol/jump diffusions create IV smiles, but at a certain point, a large enough spread between two adjacent strikes begins to seem like a reasonable opportunity.