Recently started studying about markets and finance. Its just amazing to me how modern instruments allow for such intricate bets and speculation about the market, an undirectional trade just on the volatility! Thanks for your content. Really enjoying it!
Thank you Patrick for your explanation. Clear as always. One query though. For someone who is delta neutral and Short on options, the only way to earn the money is when they sell on high IV and realised vol turns out to be lower than IV. Is this the only scenario when they'll earn money?
Essentially yes. Or if the underlying was very volatile but you didn’t negative gamma scalp and didn’t lock in any losers and the underlying just happened to finish where it started at option expiration. The ideal scenario is for the underlying to slowly creep towards your short delta neutral option and expire at the strike.
How do you view options selling as a long term strategy? Vix always reverts to its mean and so selling options in high vol environment seems like great way to make consistent returns.
The suitability of the strategy relates to your objectives, tolerances, etc. Here's research on the efficacy of selling options premium when expecting implied volatility to mean-revert: - th-cam.com/video/JGMAYDOhM5s/w-d-xo.html - th-cam.com/video/b_9KN3iKgDQ/w-d-xo.html
There are buy write etfs. As of Nov 2023 this is a crowded trade as it was prior to volmageddon in Feb 2018. Adding a theta collecting strategy into your asset allocation diversification may smooth out the returns of your total investment portfolio.
Hi Patrick. Would it be safe to say that the VXXB uses a delta neutral strategy? I'm trying to understand the financial mechanics of it but I can't found the specific method it uses. I understand that the VXXB is a bond on the originator balance sheet so it is like a debt obligation, but they should be doing something with the capital collected from the offering to hedge the risk. Don't know if I'm looking at it the right way or if you have some reference to understand it better if I'm missing something. Tks for the playlist.
Hi Patrick, really love your videos! Do you have advise on minimum capital required to do options trade & hedging? Also do you have advise for people who are just starting to get hands on in options trading?
Retailers generally are better off not trading in general and definitely not options as their characteristics can be difficult to fully comprehend the extent of. I would definitely recommend reading up a lot on the topic and understand the risk characteristics beforehand. His book, Trading and Pricing financial derivatives is probably a place to start.
I agree this isn’t really for retail investors. If you want to gamble on volatility just use vix futures. Shelly Natenberg’s Option Volatility and Pricing used to be the floor traders bible. But I’m sure there are other good books. Natemberg is easy to read and understand. Often taught from first principles so you understand rather than memorize.
Hi Patrick. When you say "periodically re-hedge", what triggers this adjustment? is it when delta or the stock price has moved a certain amount or is there some other signal..something in the chart etc? Also, how far out would you buy or sell the option you're hedging?
Different traders do this differently, some will base it on how much the market has moved, others will just rebalance once a day. This kind of decision will affect how profitable you are, and is where real life differs from financial theory. In theory, rebalancing is done continuously, but in real life this would drive trading costs too high to make sense.
@@PBoyle Thank you Patrick. I've experimented in the past with delta hedging short volatility positions, but without success...my stock position always lost more than the option premium collected. I suspect because I trade a small account ( £15k ), 1 contract, commissions may not have helped either. As a mostly self taught options seller, it never occurred to me to try long vol delta hedging though, so I'll experiment with that.. it would be good to have some long vol strategies in my armoury to help balance my portfolio.. I have a feeling we'll see some rather high IV over the coming year or so. Thanks for the great channel and insights... sub'ed and book ordered! :)
The delta depends on the Volatility. So, what volatility should be used for the dynamic hedging(Rebalancing)? Your estimate or the current market estimate? Also, if those estimates converge, perhaps, the option should be eliminated?
You might want to make your own estimate of forward volatility (implied and realized) in any case (at least to cover the time period until your next rebalance). Part of making a trade is establishing expectations for market conditions -- including how volatility changes might impact your delta, and disagreement with the market would always have room to be expressed in the trades. If I'm rebalancing and I believe vol (implied or realized) dislocated temporarily, I'm less interested in which representation of volatility I use compared to "leaning" my rebalance in the anticipated direction so I don't have extra cleanup during the next rebalance. Also agreed - if you've reached consensus with the market, that's a good argument to eliminate the position.
Current. Exception might be for single name options which can be more binary like before earnings. I’d take out the wings (assuming I’m always net long the wings) and hedge to a vol that prevailed before the earnings pump in case earnings is a bust. With options with less binary outcomes like index options just hedge to the current vols. Removing long wings from the position helps smooth pnl since hedging wings is silly anyway. It just increases risk.
Hey Patrick. Is volatility hedging a common strategy as well? I.e. owning the underlying and dynamically hedging out volatility using options, for investors looking for smoother sailing on a directional bet.
The most common scenarios I hear about to supplement long exposure are: 1. buying volatility to reduce downside exposure 2. Selling volatility to reduce cost basis Both of these seem to emphasize reducing downside portfolio volatility rather than increasing upside portfolio volatility. However for a more "fully managed" volatility exposure, perhaps certain structured products are the most similar (eg, "you get exposure to the S&P500, but your annual gains are capped at 6% and your losses at -8%"). One could imagine different portfolio constructions to achieve this (eg, combination of synthetic long exposure plus selling volatility skew). Of course the catch in all of this is that moving from an all-underlying portfolio to one that includes explicit volatility exposure means introducing at least one additional market exposure -- meaning portfolio volatility and returns could be worse than the alternative simply because you've introduced additional market forces which may not always behave consistently with the objectives of opening those positions.
Quick question, as a volatility trader how should I choose the strike of the option to best express the mispricing between implied and forecast realised vol?
Choose the strike where you believe you can capture the best of the mispricing! Eg, you reason that vomma (2nd order Greek) factors your hypothesis, so you choose farther OTM strikes to increase your exposure to possible price correction. Or, eg, you choose strikes closer to ATM simply to prevent slippage. Strike selection comes from various parts of the analysis.
Hello Patrick. Thanks for your wonderful and useful videos. I've a question about Dynamic Hedging. When you calculate the delta, what value of volatility do you use? Implied Volatility, Historical volatility, or diffuse volatility + expected Jump Volatility? It makes a big difference in calculating the delta and consequently the number of the Long/short underling shares. Another question: What is the difference in dynamically hedging an options that has the strike at the money beside one that is OTM or ITM? In the example you provided could it have had a difference in the profit/loss output?
Hi Marcello, You just use the current level of volatility being priced in the market right now - the implied volatility. The opint of calculating the Greeks like delta is to see how much the option price changed is all other things are held equal and just one thing is changed. For delta, the only thing that needs to be changed is the price of the underlying.
You are exposed to volatility when selling strangles, and tpyou hv to adjust strangles as well, besides , the drawdowns are huge in strangles as you are selling naked options
The difference between a short strangle and adjusting delta using the underlying is: the difference between shorting an option and trading the underlying. Shorting an option generally brings short Vega and gamma exposure where trading the underlying wouldn't have Greek characteristics. So one answer to your question might be "they trade the underlying instead of more options because they don't want any further Greek exposure" There are other "answers," but that's a methodical way to get at one.
You can roll your options to achieve delta neutral but you’re giving up a lot of edge compared to scalping the gamma with the underlying. You’re also introducing more Greeks when you will options rather than just adjusting one Greek (delta) when scalping the delta.
It is simply how institutional traders hedge their exposure to the options that they buy and sell to customers. Retail investors tend not to do this, but to truly understand options and how they are priced you need to understand how the directional exposure is hedged and that once it is hedged you are left with volatility exposure. The insight that this strategy can replicate the payoff of an option is the most important insight of the Black & Scholes formula. Using this strategy you can create the payoff of an option without needing an options market to exist.
Apologies for the drop in audio/video quality for todays class. I was travelling for work when I recorded this class. Hopefully you find it useful.
Patrick Boyle ok. Thanks
Recently started studying about markets and finance. Its just amazing to me how modern instruments allow for such intricate bets and speculation about the market, an undirectional trade just on the volatility! Thanks for your content. Really enjoying it!
Brilliant! Clearest explanation on how hedging against realized volatility costs the short volatility position.
Your older content is so underrated. Thank you for sharing your knowledge!
The only problem I have with your videos is wishing I had found them earlier! Great video
Very awesome. Best channel period.
Love this video. Thanks for explaining so crisply!
Glad it was helpful!
True relative value vol arb is Current IV vs Historical IV: Vega PnL = vega * dIV
IV vs RV is gamma scalping
Thank you Patrick for your explanation. Clear as always. One query though. For someone who is delta neutral and Short on options, the only way to earn the money is when they sell on high IV and realised vol turns out to be lower than IV. Is this the only scenario when they'll earn money?
Essentially yes. Or if the underlying was very volatile but you didn’t negative gamma scalp and didn’t lock in any losers and the underlying just happened to finish where it started at option expiration.
The ideal scenario is for the underlying to slowly creep towards your short delta neutral option and expire at the strike.
@@75pdubs thank you
How do you view options selling as a long term strategy? Vix always reverts to its mean and so selling options in high vol environment seems like great way to make consistent returns.
The suitability of the strategy relates to your objectives, tolerances, etc.
Here's research on the efficacy of selling options premium when expecting implied volatility to mean-revert:
- th-cam.com/video/JGMAYDOhM5s/w-d-xo.html
- th-cam.com/video/b_9KN3iKgDQ/w-d-xo.html
There are buy write etfs. As of Nov 2023 this is a crowded trade as it was prior to volmageddon in Feb 2018. Adding a theta collecting strategy into your asset allocation diversification may smooth out the returns of your total investment portfolio.
Hi Patrick. Would it be safe to say that the VXXB uses a delta neutral strategy? I'm trying to understand the financial mechanics of it but I can't found the specific method it uses. I understand that the VXXB is a bond on the originator balance sheet so it is like a debt obligation, but they should be doing something with the capital collected from the offering to hedge the risk. Don't know if I'm looking at it the right way or if you have some reference to understand it better if I'm missing something. Tks for the playlist.
Love your content. FYI, the Amazon link for your book is invalid
Hi Patrick, really love your videos! Do you have advise on minimum capital required to do options trade & hedging? Also do you have advise for people who are just starting to get hands on in options trading?
Retailers generally are better off not trading in general and definitely not options as their characteristics can be difficult to fully comprehend the extent of. I would definitely recommend reading up a lot on the topic and understand the risk characteristics beforehand. His book, Trading and Pricing financial derivatives is probably a place to start.
I agree this isn’t really for retail investors. If you want to gamble on volatility just use vix futures. Shelly Natenberg’s Option Volatility and Pricing used to be the floor traders bible. But I’m sure there are other good books. Natemberg is easy to read and understand. Often taught from first principles so you understand rather than memorize.
Hi, i just wanted to ask you how a retail could run a strategy like this from home, is it possible? thanks
Is the spot rate the thing that implied volatility predicts at whichever expiration date you choose?
at 13:28, why the value of p=0.902? Shouldnt it be 0.9?
Thanks for the video!!! Super helpful
Hi Patrick. When you say "periodically re-hedge", what triggers this adjustment? is it when delta or the stock price has moved a certain amount or is there some other signal..something in the chart etc? Also, how far out would you buy or sell the option you're hedging?
Different traders do this differently, some will base it on how much the market has moved, others will just rebalance once a day. This kind of decision will affect how profitable you are, and is where real life differs from financial theory. In theory, rebalancing is done continuously, but in real life this would drive trading costs too high to make sense.
@@PBoyle Thank you Patrick. I've experimented in the past with delta hedging short volatility positions, but without success...my stock position always lost more than the option premium collected. I suspect because I trade a small account ( £15k ), 1 contract, commissions may not have helped either. As a mostly self taught options seller, it never occurred to me to try long vol delta hedging though, so I'll experiment with that.. it would be good to have some long vol strategies in my armoury to help balance my portfolio.. I have a feeling we'll see some rather high IV over the coming year or so. Thanks for the great channel and insights... sub'ed and book ordered! :)
Could you use gamma to figure out how many shares to buy or sell?
The delta depends on the Volatility. So, what volatility should be used for the dynamic hedging(Rebalancing)? Your estimate or the current market estimate? Also, if those estimates converge, perhaps, the option should be eliminated?
You might want to make your own estimate of forward volatility (implied and realized) in any case (at least to cover the time period until your next rebalance). Part of making a trade is establishing expectations for market conditions -- including how volatility changes might impact your delta, and disagreement with the market would always have room to be expressed in the trades.
If I'm rebalancing and I believe vol (implied or realized) dislocated temporarily, I'm less interested in which representation of volatility I use compared to "leaning" my rebalance in the anticipated direction so I don't have extra cleanup during the next rebalance.
Also agreed - if you've reached consensus with the market, that's a good argument to eliminate the position.
Current. Exception might be for single name options which can be more binary like before earnings. I’d take out the wings (assuming I’m always net long the wings) and hedge to a vol that prevailed before the earnings pump in case earnings is a bust. With options with less binary outcomes like index options just hedge to the current vols. Removing long wings from the position helps smooth pnl since hedging wings is silly anyway. It just increases risk.
Hey Patrick.
Is volatility hedging a common strategy as well?
I.e. owning the underlying and dynamically hedging out volatility using options, for investors looking for smoother sailing on a directional bet.
The most common scenarios I hear about to supplement long exposure are:
1. buying volatility to reduce downside exposure
2. Selling volatility to reduce cost basis
Both of these seem to emphasize reducing downside portfolio volatility rather than increasing upside portfolio volatility.
However for a more "fully managed" volatility exposure, perhaps certain structured products are the most similar (eg, "you get exposure to the S&P500, but your annual gains are capped at 6% and your losses at -8%"). One could imagine different portfolio constructions to achieve this (eg, combination of synthetic long exposure plus selling volatility skew).
Of course the catch in all of this is that moving from an all-underlying portfolio to one that includes explicit volatility exposure means introducing at least one additional market exposure -- meaning portfolio volatility and returns could be worse than the alternative simply because you've introduced additional market forces which may not always behave consistently with the objectives of opening those positions.
Quick question, as a volatility trader how should I choose the strike of the option to best express the mispricing between implied and forecast realised vol?
Choose the strike where you believe you can capture the best of the mispricing!
Eg, you reason that vomma (2nd order Greek) factors your hypothesis, so you choose farther OTM strikes to increase your exposure to possible price correction.
Or, eg, you choose strikes closer to ATM simply to prevent slippage.
Strike selection comes from various parts of the analysis.
Hello Patrick. Thanks for your wonderful and useful videos.
I've a question about Dynamic Hedging.
When you calculate the delta, what value of volatility do you use?
Implied Volatility, Historical volatility, or diffuse volatility + expected Jump Volatility?
It makes a big difference in calculating the delta and consequently the number of the Long/short underling shares.
Another question:
What is the difference in dynamically hedging an options that has the strike at the money beside one that is OTM or ITM?
In the example you provided could it have had a difference in the profit/loss output?
Hi Marcello, You just use the current level of volatility being priced in the market right now - the implied volatility. The opint of calculating the Greeks like delta is to see how much the option price changed is all other things are held equal and just one thing is changed. For delta, the only thing that needs to be changed is the price of the underlying.
Is the volatility trader writing puts or are they trading out contracts like some do for premium.
If you buy an option you are long vol. if you short an option you are short vol.
HI Patrick great videos but do look at the camera!
Why don’t the trader just sell a strangle to be delta neutral instead of constantly readjusting?
You are exposed to volatility when selling strangles, and tpyou hv to adjust strangles as well, besides , the drawdowns are huge in strangles as you are selling naked options
The difference between a short strangle and adjusting delta using the underlying is: the difference between shorting an option and trading the underlying.
Shorting an option generally brings short Vega and gamma exposure where trading the underlying wouldn't have Greek characteristics.
So one answer to your question might be "they trade the underlying instead of more options because they don't want any further Greek exposure"
There are other "answers," but that's a methodical way to get at one.
You can roll your options to achieve delta neutral but you’re giving up a lot of edge compared to scalping the gamma with the underlying. You’re also introducing more Greeks when you will options rather than just adjusting one Greek (delta) when scalping the delta.
The shaggy lyre unexpectedly sparkle because vibraphone anaerobically succeed by a ablaze entrance. short, high-pitched unit
This is speculation, a negative behavior to avoid
It is simply how institutional traders hedge their exposure to the options that they buy and sell to customers. Retail investors tend not to do this, but to truly understand options and how they are priced you need to understand how the directional exposure is hedged and that once it is hedged you are left with volatility exposure.
The insight that this strategy can replicate the payoff of an option is the most important insight of the Black & Scholes formula. Using this strategy you can create the payoff of an option without needing an options market to exist.
@@PBoyle Wouldn't Trading Fees harm the long vol's profits?