26 lines
1.8 KiB
Plaintext
26 lines
1.8 KiB
Plaintext
When Delta Neutral Isn’t Direction
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Indifferent
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Many dynamic-volatility option positions, such as the risk reversal, have
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vega risk from potential IV changes resulting from the stock’s moving. This
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is indirectly a directional risk. While having a delta-neutral position hedges
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against the rather straightforward directional risk of the position delta, this
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hidden risk of stock movement is left unhedged. In some circumstances, a
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delta-lean can help abate some of the vega risk of stock-price movement.
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Say an option position has fairly flat greeks at the current stock price. Say
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that given the way this particular position is set up, if the stock rises, the
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position is still fairly flat, but if the stock falls, short lower-strike options
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will lead to negative gamma and vega. One way to partially hedge this
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position is to lean short deltas—that is, instead of maintaining a totally flat
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delta, have a slightly short delta. That way, if the stock falls, the trade
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profits some on the short stock to partially offset some of the anticipated
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vega losses. The trade-off of this hedge is that if the stock rises, the trade
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loses on the short delta.
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Delta leans are more of an art than a science and should be used as a
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hedge only by experienced vol traders. They should be one part of a well-
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orchestrated plan to trade the delta, gamma, theta, and vega of a position.
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And, to be sure, a delta lean should be entered into a model for simulation
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purposes before executing the trade to study the up-and-down risk of the
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position. If the lean reduces the overall risk of the position, it should be
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implemented. But if it creates a situation where there is an anticipated loss
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if the stock moves in either direction and there is little hope of profiting
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from the other greeks, the lean is not the answer—closing the position is. |