what is the best way to trade skew while hedging delta, gamma, vega, and theta?
- Thread starter njrookie
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GordonTheGekko
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NJR, leveraged ETF's work well. Some/many have limits when you put your entire purchasing power on one (i.e. one can only buy 130% of TNA, a x3 small cap leveraged) but for hedging, you can use the full leverage power.
Lots of good information here. It is going to take me a bit more time to absorb. I will write more later. I want to write about my plan in longer term.
I have a decent model predicting the direction of imp vol right now with 20% rsq. I want to combine it with skew, which is somewhat orthogonal to level. The eventual goal is to pick the right options to trade on the surface, ie calender skew, strike skew, and level of the surface. "right" in the sense that it lowers trading costs while hedging unnecessary risks.
I came from a quant modeling background, and am not quite up to the seasoned traders in terms of option terminologies. I am reading a few books and trying to catch as fast as I can.
Thanks again for anyone who is participating in the thread.
njrookie
I have a decent model predicting the direction of imp vol right now with 20% rsq. I want to combine it with skew, which is somewhat orthogonal to level. The eventual goal is to pick the right options to trade on the surface, ie calender skew, strike skew, and level of the surface. "right" in the sense that it lowers trading costs while hedging unnecessary risks.
I came from a quant modeling background, and am not quite up to the seasoned traders in terms of option terminologies. I am reading a few books and trying to catch as fast as I can.
Thanks again for anyone who is participating in the thread.
njrookie
So you want to trade the skew but immunize yourself from any delta, vega, gamma, and theta risk?
That is a pretty tall order!
I can't see how to do that, or even get close, without an correlation based synthetic skew trade embedded in your position. So you'd lose on the embedded synthetic what you'd gain in your overt bet.
The problem is that movements in the skew are not independent of the four greeks you are seeking to hedge out.
That is a pretty tall order!
I can't see how to do that, or even get close, without an correlation based synthetic skew trade embedded in your position. So you'd lose on the embedded synthetic what you'd gain in your overt bet.
The problem is that movements in the skew are not independent of the four greeks you are seeking to hedge out.
I agree I am making the trade too complex.
The difficulty is not about neutralizing greek risks. Locally you can use 4 options to totally hedge 4 greeks mathematically. However 2nd order partial derivatives can wreck the trade for a large move in the underlying.
As the previously poster stated, the skews are not independent of greeks and of the underlying.
njrookie
The difficulty is not about neutralizing greek risks. Locally you can use 4 options to totally hedge 4 greeks mathematically. However 2nd order partial derivatives can wreck the trade for a large move in the underlying.
As the previously poster stated, the skews are not independent of greeks and of the underlying.
njrookie
I am reviving the thread since I have some additional thoughts that I would like to listen to everyone's comments.
Here is the trade I have in mind if I think skew is going up (opposite if skew is expected to go down):
1. Long OTM put say at 120 (let us take underlying at 125 for example) delta about -30;
2. Short OTM call at 130, and another delta at -30.
3. zero out delta with a long in the underlying (add 60 delta).
The long and short in the options pretty much have offsetting vega and gamma and theta. So the bet is relative safe. You of course can fine tune the ratio of the options to have a better gamma/vega/theta matching.
The trade effectively is a collar but without 100% in the underlying. What do you think the margin requirement will be for this (I have IB PM account)?
My thought should be:
1. Collar margin, plus
2. Additional margin for the reduced position in the underlying.
The margin requirement should be quite efficient in this case.
If you expect skew to go down, do the opposite.
njrookie
Here is the trade I have in mind if I think skew is going up (opposite if skew is expected to go down):
1. Long OTM put say at 120 (let us take underlying at 125 for example) delta about -30;
2. Short OTM call at 130, and another delta at -30.
3. zero out delta with a long in the underlying (add 60 delta).
The long and short in the options pretty much have offsetting vega and gamma and theta. So the bet is relative safe. You of course can fine tune the ratio of the options to have a better gamma/vega/theta matching.
The trade effectively is a collar but without 100% in the underlying. What do you think the margin requirement will be for this (I have IB PM account)?
My thought should be:
1. Collar margin, plus
2. Additional margin for the reduced position in the underlying.
The margin requirement should be quite efficient in this case.
If you expect skew to go down, do the opposite.
njrookie
while your question is about margin and although "all trades" are influenced by IV(some more than others), the synthetic combo is one trade where I wouldn't even bother paying attention to vertical skew: the greeks just don't make that much of a difference with it. vertical skew make much more difference when trading flies, ratio backspreads, and condor.
I'm a lightweight when it comes to the Greeks and I know nothing about PM. So what am I doing here???
Your equidistant 60 share collar isn't going to benefit much, if at all, from a bump up in IV because what you gain on your long put will be lost on your short call. In addition, any significant up move in IV will take you away from neutrality much faster if the UL moves.