Kevin_in_GA
4,599 posts
msg #92397
- Ignore Kevin_in_GA |
5/9/2010 11:20:17 PM
Quick question for some of the options gurus out there ...
I want to better understand how one hedges long positions in stocks or ETFs with options. For those who have not seen my thread on once-a-month trading between IWM, EEM, and SHY, it's average monthly return since Jan 2003 has been ~2%. I would like to also put a hedge in place, but since the monthly return is 2%, I would not want to use any more capital than necessary to cover against a market correction like we saw this past week.
Let's say you bought 1000 shares of IWM at its current market price of $65.37 (which has with a typical monthly volatility of 2.4%) and want to hedge against a downside move.
My current thinking (please challenge this if it is not sound) is to buy a put two or more months out, but I'm not sure which would be the most effective one to buy. Here are the current June puts and their associated numbers:
Jun 65 put - 3.33 delta is -0.46
Jun 64 put - 2.94 delta is -0.41
Jun 63 put - 2.59 delta is -0.37
Jun 62 put - 2.29 delta is -0.33
The other Greeks are the same, for all intents and purposes of this analysis.
If IWM closed down 3% on the month, your loss in this instance would be $65.37 * 0.03 *1000 = $1961. Stock would close at $65.37 * 0.97 = $63.41, for a loss of $1.96 per share.
That would mean that the put options, assuming no meaningful time decay for this instance, would be at the following values:
Jun 65 put - 3.33 + (1.96 * 0.46) = 4.23 (a gain of 27%)
Jun 64 put - 2.94 + (1.96 * 0.41) = 3.74 (a gain of 27%)
Jun 63 put - 2.59 + (1.96 * 0.37) = 3.31 (a gain of 28%)
Jun 62 put - 2.29 + (1.96 * 0.33) = 2.93 (a gain of 28%)
So regardless of which one I buy, the return is the same?
I would not want to use more than 1% of my trading capital on this hedge, and am assuming that at the end of the month any puts I buy will expire. So I would have spent an extra $653 on the put protection, which would have generated only $183 in profit, only partially offsetting a $1961 loss.
So, is this correct - for every 1% used for put protection, you get a 10% offset of your loss (assuming that time decay is excluded for now). If you factor in bid/ask spread costs and time decay, how can this be seen as a smart move? If you have bet correctly on the stock direction, your options expire worthless, and if you were wrong they barely cover their own costs unless the drop is significant.
Over the long haul this would seem to be a huge drag on growth.
Comments?
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Eman93
4,750 posts
msg #92399
- Ignore Eman93 |
5/9/2010 11:42:44 PM
Once you are in the money....... the option acts just like the stock...... moving dollar for dollar..... the spread on the bid ask is what the market maker gets for supplying liquidity. He has to cover every trade..
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Eman93
4,750 posts
msg #92400
- Ignore Eman93 |
5/9/2010 11:56:47 PM
You use options to buy, sell and hedge your position for big money players... say you are a big hedge fund and want to buy 1 million shares of IMAX at 18 so you buy the in the money calls when the price ticks down to the low of the day... you can get a good price... and buy a million shares at that exact price..
Same for selling.... lets use the same trade ....you want to sell IMAX at 21 all you do is just sell the 21 call and bank the coin.. you can use that to buy a catastrophic put protection say at 15...
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Eman93
4,750 posts
msg #92401
- Ignore Eman93 |
5/10/2010 12:08:59 AM
If IWM closed down 3% on the month, your loss in this instance would be $65.37 * 0.03 *1000 = $1961. Stock would close at $65.37 * 0.97 = $63.41, for a loss of $1.96 per share.
That would mean that the put options, assuming no meaningful time decay for this instance, would be at the following values:
Jun 65 put - 3.33 + (1.96 * 0.46) = 4.23 (a gain of 27%) == 65 - 63.41 = a gain of 1.59 = (1.59 / 3.33) * 100 = 48%
Jun 64 put - 2.94 + (1.96 * 0.41) = 3.74 (a gain of 27%) == 64 - 63.41 = a gain 0.59
Jun 63 put - 2.59 + (1.96 * 0.37) = 3.31 (a gain of 28%) expire worthless
Jun 62 put - 2.29 + (1.96 * 0.33) = 2.93 (a gain of 28%) expire worthless
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Eman93
4,750 posts
msg #92402
- Ignore Eman93
modified |
5/10/2010 12:15:11 AM
http://en.wikipedia.org/wiki/Black%E2%80%93Scholes
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Kevin_in_GA
4,599 posts
msg #92408
- Ignore Kevin_in_GA |
5/10/2010 6:48:33 AM
Jun 65 put - 3.33 + (1.96 * 0.46) = 4.23 (a gain of 27%) == 65 - 63.41 = a gain of 1.59 = (1.59 / 3.33) * 100 = 48%
Jun 64 put - 2.94 + (1.96 * 0.41) = 3.74 (a gain of 27%) == 64 - 63.41 = a gain 0.59
Jun 63 put - 2.59 + (1.96 * 0.37) = 3.31 (a gain of 28%) expire worthless
Jun 62 put - 2.29 + (1.96 * 0.33) = 2.93 (a gain of 28%) expire worthless
++++++++++++++++
Sorry - I was not clear. These options are several months out, and therefore would not expire at the end of this month.
I thought that if you bought farther OTM puts, the fact that they cost less would allow you to but more contracts, and therefore get more bang for the buck. I think what I forgot to include in this analysis is the number of contracts one could buy, since if you have 10 contracts instead of 5, you will make more.
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medowz
59 posts
msg #92451
- Ignore medowz |
5/11/2010 2:39:01 AM
Kevin,
Off the subject a bit, but ThinkorSwim has a great tool to evaluate your hedges based on the Greeks. You can hedge single stocks or entire portfolios based on any Greek you want. Their paper trading account is free, too. It would be hard to beat it for hedging. The tool is called Analyze. All the best.
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Kevin_in_GA
4,599 posts
msg #92454
- Ignore Kevin_in_GA |
5/11/2010 6:42:20 AM
Sounds like just what I was looking for - Thanks!
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four
5,087 posts
msg #133453
- Ignore four |
1/1/2017 2:43:33 AM
https://www.tastytrade.com/tt/shows/the-skinny-on-options-data-science/episodes/hedging-a-large-account-w-spreadsheet-09-29-2016
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