Which Opt to choose ?

[traderwald]

Hi guys,

In order to hedge a open underlying position, should I go with opt that has higher theta and delta or lower theta and delta ?

If it is higher then it helps me to close the position a bit more quickly either by exercise or closing the trade and also has lower premium. If it is lower then the premiums are higher but theta is lower.

What is the strategy that experts would recommend to this ?

 

[tommcginnis]

• Your understanding of delta and theta is incomplete, distorted, and wrong.
• You are captured by a thought that the answer to your question lies in 'the Greeks'.
• Options are insurance. Insure your underlying position the same way you'd insure your car, your house, your health, etc.: you decide what protection 'product' you need, and you go buy it. That will be a combination of time and strike.

Run your choice through some alternate scenarios -- if the price of the asset rises, will you make out better or worse? What if it falls? What if the necessary time horizon extends? Shortens?

Lastly, put your asset position on a profit/loss graph, and then overlay your option choice.
• Is that picture adequate?
• Would further additions extend returns over risk? (for example, a spread {calendar or vertical} or synthetic long{or short}?

 

[ffs1001]

In order to hedge a open underlying position, should I go with opt that has higher theta and delta or lower theta and delta ?

Why the vagueness? Post the actual position you have, and the options prices, strikes, details of the various expiries you are considering as hedges and people will be able to give a proper answer.

 

[traderwald]

Hi @tommcginnis

Thank you for your reply.

I am looking to put this on a graph but on IB it is not showing the information. I need to figure how to do this on TWS.

@ffs1001

As of now, I am looking at how this calculation is to be done. No position as of now.

 

[spindr0]

Selecting a put hedge involves several trade offs. It's like home insurance. If you use a select a higher put strike, you pay more for the hedge but you have better protection. If you use an OTM put, you pay less for the insurance but you have a higher deductible (the underlying can lose more before the insurance kicks in).

On an options 101 level, set up a spreadsheet that calculates the cost of the entire position (underlying + put), the upside break even point, the maximum loss point, the amount of the maximum loss and the cost per day of the put. Uses a number of strikes, starting with ATM and lower, adjacent strikes. That will show you the trade off of cost of protection versus amount of protection. Then compare the results of all puts analyzed and look for the one where the risk versus cost is most suitable for you.

If you have a higher level of option experience and access to option analytics, graph each put/underlying combo. If the program offers time slices, you can observe how each combo position performs over various time periods between now and expiration.

I like collars for hedging since they can be structured for little to no cost. Of course, you have to be willing to give up the upside. If the underlying cooperates and rises gradually, you might even get to roll the collar up, locking in gain while giving yourself additional upside profit potential (a debit unless near the upper strike at expiration).

Since you mentioned theta, avoid short term options for hedging unless

(1) you have some magically ability to time price movement well or

(2) you are collaring

...because otherwise, the premium will be like sand in your hands, disappearing faster and faster.

 

[traderwald]

Selecting a put hedge involves several trade offs. It's like home insurance. If you use a select a higher put strike, you pay more for the hedge but you have better protection. If you use an OTM put, you pay less for the insurance but you have a higher deductible (the underlying can lose more before the insurance kicks in).

On an options 101 level, set up a spreadsheet that calculates the cost of the entire position (underlying + put), the upside break even point, the maximum loss point, the amount of the maximum loss and the cost per day of the put. Uses a number of strikes, starting with ATM and lower, adjacent strikes. That will show you the trade off of cost of protection versus amount of protection. Then compare the results of all puts analyzed and look for the one where the risk versus cost is most suitable for you.

If you have a higher level of option experience and access to option analytics, graph each put/underlying combo. If the program offers time slices, you can observe how each combo position performs over various time periods between now and expiration.

I like collars for hedging since they can be structured for little to no cost. Of course, you have to be willing to give up the upside. If the underlying cooperates and rises gradually, you might even get to roll the collar up, locking in gain while giving yourself additional upside profit potential (a debit unless near the upper strike at expiration).

Since you mentioned theta, avoid short term options for hedging unless

(1) you have some magically ability to time price movement well or

(2) you are collaring

...because otherwise, the premium will be like sand in your hands, disappearing faster and faster.

Thank you spidr for your reply.

When it comes to collars, the concern is that when the underlying moves in profit both the long and short go to deduct from it. And with delta of almost 1 it would mean that to get full profit the opts need to close with the underlying in profit zone. Closing prior to that may me small profit on it

How do you manage this.

Need to check on IB how to make the graph including the UL contract

 

[spindr0]

When it comes to collars, the concern is that when the underlying moves in profit both the long and short go to deduct from it. And with delta of almost 1 it would mean that to get full profit the opts need to close with the underlying in profit zone. Closing prior to that may me small profit on it

How do you manage this.

A collar is synthetically equal to a vertical. If the defined boundaries of a vertical are acceptable, you're good to go. If you don't like having a capped upside, the a vertical (or collar) isn't for you.

Don't think in black and white terms of 'full profit'. Booking a large percent of the total profit before expiration is not a bad thing (adjust/close).

I put much more effort into managing the long option side of a vertical or collar. If it's an investment position, I'll often roll the long leg away from price, pyramiding the number of contracts up. I just want to stay in the game with modest losses when wrong and the opportunity for an occasionally larger win when right.