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Showing content with the highest reputation on 04/29/2012 in all areas

  1. 1 point
    As a non-directional trader, I'm trying not to be dependent on the market direction. My goal is to make money in any market. To achieve that goal, I need to constantly balance my portfolio in terms of direction and volatility. The first goal is being as delta neutral as possible. That means starting most trades with balanced deltas. What does it mean? If the stock is trading at $50, and I buy a 50 straddle, I'm delta neutral. If I buy a 55 straddle, I'm delta negative. The puts which are ITM have higher delta than the calls which are OTM. So if the stock goes down, the delta of the puts starts increasing faster than delta of the calls decreasing, overall delta becomes even more negative and the trade makes money. However, if the stock goes up, the trade becomes more delta neutral, the puts are losing more than the calls are gaining, and the trade is likely to lose money. What happens if I started delta neutral (with 50 straddle in our example) and the stock went up to 55? It depends if the trade became profitable by that time. If the answer is positive, we can close the 50 straddle and roll to 55 straddle. But what if the profit is still insufficient? In this case, we can let the trade run hoping for the stock continue rising, but we also risk a reversal. One way to hedge yourself, at least partially, is opening the next trade slightly delta negative. This will balance the total delta exposure of the portfolio. For example, after opening the RUT Iron Condor with RUT at 785, the trade became delta negative after the recent run to 825. So I might choose opening my next trades with slightly positive delta to balance my total delta. To be truly non-directional, it is not enough to balance the deltas. We also need to balance our theta and vega exposure. That means that we will have to have a mixture of theta positive trades, like Iron Condors and calendars, and theta negative plays, like our earnings plays. To balance the vega, we need a mixture of vega positive and vega negative plays. ICs are vega negative - they benefit from decrease in IV. The aim is to open an IC on a down day when IV spikes. Calendars tend to be vega positive as well. The reason is that longer dated options are supposed to benefit more from IV increase than shorter dated options. Our earnings plays are vega positive. They will be the most profitable when IV jumps. SO having a mix of strategies will help us to be ready to all scenarios in terms of overall market volatility. This post has been promoted to an article
  2. 1 point
    you are right, a long HOG (delta or any other greek) doesn't directly hedge a short in say IBM and you can still lose on both trades. However the idea is to hedge yourself against a general move in the market (up or down). If the S&P goes up, a specific stock that you have can obviously still go down but the odds are its are going to rise with the overall market. So if you are short delta on one stock the best delta hedge would be to add delta to that specific stock position (via options or shares) second best hedge if you don't want to do that is to add delta (long or short - whatever brings you overall portfolio delta closer to zero) in another stock to your portfolio. Same idea for gamma/theta - if the market doesn't move much or earnings trades aren't performing as well (as we hope for a big move) but at the same time this is the environment where IC and calendars make money (you don't wont the markets to move for these strategies) so these strategies PARTIALLY hedge each other.
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