SERVING THE QUANTITATIVE FINANCE COMMUNITY

kmiklas
Topic Author
Posts: 14
Joined: July 8th, 2016, 2:34 pm

### How to best hedge in this situation?

Hello, any opinions on how to best hedge in the following situation?- 200 shares of Apple (AAPL) as the financial instrument for algorithmic day-trading.- The goal is to protect against a large (>10%) downspike in the market.- I do not plan to keep the position open overnight. I will buy the equity and the option in the morning, and sell at EOD.My intention is to:- Buy two contracts, with a standard unit of trade as 100 shares, for a total of 200 shares covered. - Choose the closest possible expiration date, to minimize cost.- Buy at or close to the money. This will minimize cost based on the "option smile."Any opinion?Thanks for your help.Sincerely,Keith :^)

acastaldo
Posts: 1416
Joined: October 11th, 2002, 11:24 pm

### How to best hedge in this situation?

Quote I will buy the equity and the option [each] morning, and sell at EOD.Your broker loves the idea.

Alan
Posts: 10204
Joined: December 19th, 2001, 4:01 am
Location: California
Contact:

### How to best hedge in this situation?

QuoteOriginally posted by: acastaldoQuote I will buy the equity and the option [each] morning, and sell at EOD.Your broker loves the idea.Haha!Keith, seriously, this is nuts.Study some history -- how often has AAPL dropped 10% intraday? How many times was it idiosyncratic vs. due to a general market event? If the latter, hedge the latter.My two cents.

kmiklas
Topic Author
Posts: 14
Joined: July 8th, 2016, 2:34 pm

### How to best hedge in this situation?

QuoteOriginally posted by: AlanKeith, seriously, this is nuts.Study some history -- how often has AAPL dropped 10% intraday? How many times was it idiosyncratic vs. due to a general market event? If the latter, hedge the latter.My two cents.Well, if it drops 10%, that's good news! I can make money on the put, right?

Posts: 23951
Joined: September 20th, 2002, 8:30 pm

### How to best hedge in this situation?

QuoteOriginally posted by: kmiklasQuoteOriginally posted by: AlanKeith, seriously, this is nuts.Study some history -- how often has AAPL dropped 10% intraday? How many times was it idiosyncratic vs. due to a general market event? If the latter, hedge the latter.My two cents.Well, if it drops 10%, that's good news! I can make money on the put, right?It depends on the put option's delta, whether you hold enough option contracts to fully hedge, and whether the markets are liquid enough for you to liquidate both of your positions.

kmiklas
Topic Author
Posts: 14
Joined: July 8th, 2016, 2:34 pm

### How to best hedge in this situation?

QuoteOriginally posted by: Traden4AlphaIt depends on the put option's delta, whether you hold enough option contracts to fully hedge, and whether the markets are liquid enough for you to liquidate both of your positions.Herein lies my question.If you don't have time to explain further here in this thread, would you kindly refer me to an article that offers a good treatment of the topic, with explanation and example?I've Googled all over, but am having trouble finding information that relates to high-speed trading. Most of the articles are about low-speed trading, or are general treatments of the topic; probably computer-generated articles that are little more than advertisements.
Last edited by kmiklas on June 22nd, 2016, 10:00 pm, edited 1 time in total.

Posts: 23951
Joined: September 20th, 2002, 8:30 pm

### How to best hedge in this situation?

kmiklas
Topic Author
Posts: 14
Joined: July 8th, 2016, 2:34 pm

### How to best hedge in this situation?

I read up on it a bit more. Can you please check my thinking on this?Since I'm only buying this option to protect my capital for the next few hours while I run my algo, I don't care about the time value of the option. I need to maximize the intrinsic value; that is, maximize the absolute value of delta. For a put, a delta closest to -1. So:1. A deep-in-the-money option. There, I find the absolute value of delta to be closest to 1, meaning that most of the value of the option is in the intrinsic.2. An option close to expiration. Why buy an option that expires in a month or two, or even a week? There, much of the value is in the time. Again, I need maximum coverage of my dollars now, in the intrinsic.3. Happily, the closer that I get to expiration, the cheaper the price of the option. Sadly, the wider the bid-ask spread, so if I sell at EOD, it will cost me.Forthwith, example: Today is 23-Jun-2016. AAPL is now trading at 95.62.From the option chain below, we see that the 6/24 AAPL 97 put has the highest absolute delta value, at -0.868. This will maximize intrinsic protection of my investment. If AAPL takes a plunge $5 down to 90.62, my put value will increase by$5 * 0.868 = \$4.34 per share. Respectable insurance against loss, given that I only need it for today.(Of course, if lady luck is on my side, my algo will have sold out the moment before the downspike occurred; then, it's just pure profit )
Last edited by kmiklas on June 22nd, 2016, 10:00 pm, edited 1 time in total.

bearish
Posts: 5613
Joined: February 3rd, 2011, 2:19 pm

### How to best hedge in this situation?

My gut feeling matches Alan's, but if what you are really after is a delta one option trade you should probably just pick the most liquid strike and buy a put and sell a call. While there is a theoretical American vs European option mismatch lurking in the background, that's probably not of much relevance on your time scale.

Posts: 23951
Joined: September 20th, 2002, 8:30 pm

### How to best hedge in this situation?

QuoteOriginally posted by: kmiklasI read up on it a bit more. Can you please check my thinking on this?Since I'm only buying this option to protect my capital for the next few hours while I run my algo, I don't care about the time value of the option. I need to maximize the intrinsic value; that is, maximize the absolute value of delta. For a put, a delta closest to -1. So:Are you sure the hedge is doing what you want:In the absence of the hedge, your algo is deciding whether to be 0% or 100% invested in AAPL (i.e., some amount of long exposure to the stock)In the presence of the hedge (assuming you don't attempt to buy/sell options at high frequency, too), your algo is deciding whether to be -100% or 0% invested in AAPL (i.e., some amount of short exposure to the stock)Don't forget that your position in the option does a lot more than just protect against a 10% slump in AAPL, it also subtracts any 1% gains in AAPL