Delta Hedging Straddles

[candreouTrade 59]

@Kim - I was wondering if you could provide a detailed explanation on Delta Hedging the straddle.

 

Often when I have a straddle on and I am at about 6% with good stock movement, I am not sure if I should Delta hedge by :

1) converting the straddle into strangle OR

2) by selling OTM options on the side the stock has moved.

 

It would be good to get a detailed explanation as to which one we would use when, and the benefits of each. 

 

I understand that converting to a strangle can make us delta neutral, and we can still make gamma gains from the stock move in either direction. I am not so clear how the hedging works when selling options (also which week options should we sell for the delta hedge)? Also i am not clear if we still make money if the stock moves either way?

 

An explanation with some PnL charts from Option NET would be really helpful along with when to use one Delta hedge over the other.

 

[Kim 7,958]

Our goal is to be delta neutral. So lets take the latest YUM trade as an example.

On Friday we had the May04 85.5 straddle and Apr20 short 84.5/86.5 strangle. The stock was at 86.40.



After closing the Apr20 strangle, we needed to sell Apr27 options in order to remain delta neutral. Since the stock moved from the straddle price, the best way to stay delta neutral was selling Apr27 86.5 call.

 

On Tuesday the stock moved to 85.20:



The trade became delta negative (-33 delta) so we sold Apr27 84.5 put to get back to delta neutral:



Now remember: reducing delta will turn against you if the stock continues the same direction. But our goal is to reduce risk, even if it means to reduce gains in some cases. We trade non-directionally, we do not want to take directional bets.

[candreouTrade 59]

Thanks.

Do you always try to sell the option that has the least amount of days to expiry? 

 

 

 

[Kim 7,958]

I would be usually looking at 7-10 calendar days to expiration, but sometimes there are exceptions.

[candreouTrade 59]

So when would you prefer converting a straddle to a strangle as a delta hedge strategy in favour of selling options?

Or do we no longer delta hedge like this.

 

[Kim 7,958]

We used to do it when we did pure straddles. Now when we do hedged straddles we hedge with selling shorter term options.

[candreouTrade 59]

But if we decide to do normal straddles, and the price of the normal straddle is good in terms of RV. Do we still use delta hedging by converting to strangles or do we sell options?

 

I recently came across this issue when selling pure straddle on SBUX.

Edited April 26, 2018 by candreouTrade

[Kim 7,958]

If we are very close to earnings, we might do straddle only. Otherwise hedged straddle.