Interesting Options Risk-Hedging Strategy

[Kevin K.]

Some of the content here is beyond my pay grade but I thought it would be of interest to several much more knowledgeable folks who post here:

https://movement.capital/how-to-protect ... et-timing/

Adam is a smart young guy. I first learned about him when I ran across his excellent series of posts on TIPS and have been checking in ever since.

[Mark Leavy]

With slippage and liquidity, you can't really get the prices that he used for the simulation. And in reading through it, I missed whether he was properly accounting for decay costs. I'm sure he did, I just missed it.

But in every situation where I have tried to gin up a scheme to use options to reduce downside, I've never found one where the savings don't show up somewhere else as a cost. Maybe not with the same frequency or volatility. But it shows up somewhere. And it balances out. If it didn't, the arbs would arb it out. And you and I pay much more in slippage than the big guys do.

I admit, I could be missing something important. I skimmed the article pretty quickly, much like when I read an article on the newest perpetual motion machine or a 'free energy' device. Same same.

[Kevin K.]

You're probably right Mark. There are others here who seem to be comfortable with the world of options trading that I thought might get something out of the article but it has no appeal to me. I'd rather hedge the downside with plenty of T-bills and gold. I do think using BSV for a chunk of one's cash/short-term bond allocation as he suggests is a pretty good (or less bad, in today's insane fixed income world) option, but that's about it for potentially actionable take-aways for me.

[Mark Leavy]

Too be fair, if you are careful with the fees, you can use options to optimize for variables that are important to you. So, it may be that this approach 'minimizes the maximum' drawdown (yes, that is a real term of art )

In that case, well worth exploring. But it would come at a cost (real or opportunity) that would also have to be evaluated.

[Kbg]

The two graphs toward the bottom capture the basics pretty well. Give up some upside for a reduction in downside.

The main thing is to try and avoid expensive times when you buy options...buy insurance when NOT needed vs. close to need. By then it’s too late and you will likely not do well.

Also...sell at 3 months to expiration as noted (usually) but not always. Depends on the intrinsic value left vs. ITM portion.

Reducing DD is worth paying a bit for when you get near or into retirement though...you can use it to up the safe withdrawal rate.

[Cortopassi]

How about marrying up a short etf as protection? Do even 1x short funds suffer decay? I feel like I’ve asked this. Ride up, sell the long, ride down, sell the short. Not 50/50, maybe 90 long 10 short?

Why is this sounding good to me right now. Not thinking straight.

Edit: Even 1x short funds rebalance daily, so not a good hold for any length of time.

[Mark Leavy]

The two graphs toward the bottom capture the basics pretty well. Give up some upside for a reduction in downside.

The main thing is to try and avoid expensive times when you buy options...buy insurance when NOT needed vs. close to need. By then it’s too late and you will likely not do well.

Also...sell at 3 months to expiration as noted (usually) but not always. Depends on the intrinsic value left vs. ITM portion.

Reducing DD is worth paying a bit for when you get near or into retirement though...you can use it to up the safe withdrawal rate.

Thanks Kbg. That makes a lot of sense.

[Kbg]

How about marrying up a short etf as protection? Do even 1x short funds suffer decay? I feel like I’ve asked this. Ride up, sell the long, ride down, sell the short. Not 50/50, maybe 90 long 10 short?

Why is this sounding good to me right now. Not thinking straight.

Edit: Even 1x short funds rebalance daily, so not a good hold for any length of time.

I have a trading system where this is very close to what I do. The system itself makes a lot and loses a lot in down turns. I marry it up with a 50% short future and it works quite nicely. I also incorporate some VXX into my quasi levered PP approach that I post on from time to time in the VP section of the site.

Negative correlation is a beautiful thing...and short something or long VIX futures is guaranteed negative correlation...no hoping like with LTTs or gold. The negative correlation is gonna happen. Of course you pay a price for the insurance and that is really what it is. However, as I think I've said a gazillion times in various posts...the assets in and of themselves are just tools with characteristics we learn from history. What really matters is the mix and how it performs as a total package.