Equity investors who want a broad-based hedge have essentially three vehicles from which to choose: equity index options (SPY, SPX, ES, etc.), VIX futures (or their ETF permutations), and VIX options. In this piece, Larry McMillan makes the case for using VIX options instead of SPX derivatives, and this is his best argument:
In my opinion, the purchase of VIX calls is a much better, more dynamic way, to approach protection. That is because VIX will explode whenever the market declines sharply,…
For an options trader, one of the most remarkable aspects of the 2008 financial crisis was that it featured months in which many options closed in or near the money when, even weeks before, they were deep out-of-the-money (DOTM) and “worthless.” The lesson is that ostensibly overpriced options are totally devoid of value, until they aren’t. This is not a new lesson: academics have spent decades creating and testing different models (Hull and White, Heston, Dupire, etc.) to better accommodate…
Felix Salmon is skeptical about the ability of average investors to protect themselves from major economic risks:
[T]here really isn’t an easy or obvious way for an investor to be highly risk-averse in this market, not when one of the biggest tail risks that people want to protect themselves against is inflation. Big investors can try taking the Taleb approach of buying large numbers of out-of-the-money options and reckoning that a bunch of them will pay off when the next crisis hits,…
Subscriber ATB raised the following insightful question in response to my comments in the July Monthly Review:
In the July monthly review you state that you don’t want to assume a stock picker’s attitude and try and pick the direction of indexes, but rather make predictions on future volatility. I also agree with this belief that no one can pick the direction of stock movements with any discernible edge. My question is why do you think you can make predictions on…
In my last post on this topic, “Why Delta Hedging Matters,” I argued that an essential aspect of options trading is hedging away unwanted risks. For most traders, the unwanted risk is usually to directional price movement, or delta risk. We discuss this issue in the context of trading iron condors a fair amount on the members area of the site, but the principle is just as important whether you’re short one call contract or managing a book of hundreds of…
Wednesday, June 30, 2010
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