The Market Measures segment from March 22nd, 2016, “Relationship Between SPX and the VIX" provided us with a “rule of thumb” that a $2 decrease in the SPY will result in a 1 point increase in the VIX. We used that ratio in an Option's Jive segment from May 9, 2016, "Offsetting Volatility Risk" to explain how to offset the risk of an increase in Implied Volatility (IV) when we have been selling option premium using Delta Neutral strategies. Do we need to offset our Vega risk in a tasty BITE sized account. If so, how should we do it?
A table comparing moves up and down in stocks and volatility was displayed. The table showed that up moves in stocks result in down moves in volatility and are helpful to Short Vega positions and hurtful to Long Vega positions. Down moves in stocks result in the opposite. Tom and Tony explained why they like to have short premium positions with negative Deltas. Tom said, “If you think fear is overpriced, the only way to protect yourself if you're wrong is to have negative Deltas.” Two separate tables showed the result of first a $2 up move in SPY and then a $2 down move. The portfolio was short 100 Vegas. Each table displayed the P/L from Delta, Vega and the total P/L for three different scenarios. The first was also being short 50 Deltas, the second was Delta Neutral and the third was long 50 Deltas. Being short the Deltas protected your position of being short 100 Vegas.
The remaining question is, how to get short the Deltas, especially in a tasty BITE sized account? The closest that you can get to completely offsetting your short Vega risk is when you are short delta equivalent to the Vega position divided by 2. The typical choices of short stock, short Futures or short calls are too capital intensive for a tasty BITE sized account. A table on how to generate short market Deltas in a tasty BITE account was displayed. They included Long Debit Put Spreads and Short Credit Call Spreads. The table showed that Deltas can be adjusted by adjusting the strikes or by allocating short Deltas in different market ETFs such as DIA (Dow Jones ETF), IWM (Russell 2000 ETF) and QQQ (Nasdaq ETF).
For more information on Negative Delta and Vega see:
Market Measures from October 28th, 2015: “Understanding Vega | Directional Trades”
Market Measures from February 6th, 2016: “The Importance of Adding Negative Delta”
Option Jive from February 16th, 2016: “Option Risks | Direction (Delta)”
Watch this segment of tasty BITES with Tom Sosnoff and Tony Battista for the important takeaways and how and why keeping negative Deltas in your account is a smart hedge against a spike in volatility, especially in a tasty BITE sized account.
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