This afternoon’s second session of the CBOE Risk Management Conference was titled Directional Options Trading and Managing Positions. The presenters were Bill Looney and Jim Bittman from CBOE along with Euan Sinclair from Bluefin Trading.
The presentation started out stating that traders need to approach a new position with a stated goal. This goal may be either to benefit from a directional outlook or implement a hedge. Euan Sinclair stated that traders are starting with a market outlook and then comparing their outlook to what the market is pricing in or expecting. Basically you are looking at implied volatility and taking a position based on your expectation of future volatility relative to expectations. The importance of having a trading plan was strongly emphasized during the presentation.
When discussing a hedge, it was noted that reasons to hedge include the inability to easily trade out of a position, you want to limit the risk factors or eliminate some of the risk factors surrounding a position, or hedging is a very inexpensive prospect.
Jim Bittman noted at the market bottom in March 2009 there were many more people concerned about the equity market than there are today as the S&P 500 has recently made new all time highs. Following up on those comments he compared and contrasted hedging an equity portfolio through buying at the money SPX puts, buying out of the money SPX puts, or implementing a collar with SPX options.
For the at the money put the benefit is lower maximum risk compared to the out of the money put and that you can still benefit from an upside move in the underlying. For the out of the money puts there is less dollar cost and the maximum risk is greater. Finally, when using a collar, the cost may be minimal or even a credit may be taken in. However, with the collar upside is sacrificed in order to pay for downside protection.
Jim finished up noting that historically when the S&P 500 sells off you would likely see the implied volatility of SPX puts rise. This increase in implied volatility may result in a better than expected outcome for the hedge.