This will be a short post but it’s an important one. I build reasonably large and often complicated looking positions in SPX. I do most of my larger trading in SPX because index options aren’t subject to the ‘wash rule’ (google it if you don’t know what I’m referring to) and they have better tax treatment than equity options for short term trades. With that said, let’s walk through a developing position. Recently I’ve been short SPX Deltas which is good as the market has been declining. Sometimes I’m short a lot of Deltas however price doesn’t move in a straight line lower. When I’m short a lot of Deltas there’ll come a time that the chart will be indicating a rally, potentially within the downtrend or potentially ending the downtrend. One never knows for sure. So I often partially Delta Hedge by adjusting the open position but I also can hedge by putting on the opposite trade. Below is my current SPX risk profile. 😮 I told you they can look a bit complicated! My primary position has been consisting of short term (1-2 wk. DTE) Put Diagonals and Calendars and when I need to hedge I have been buying 1-2 month Calls. If price moves higher and then the chart looks like another leg down is coming I’ll hedge the hedging position. In the risk profile below the Apr 4400 Calls were an original hedge to my short delta position. After price moved higher I turned those Calls into an Unbalanced Condor with a minimum $3,600 profit. That position still offered me some upside protection and allowed my to hold onto my Put Diagonals and Calendars. If I hadn’t hedged those 4400 Calls by now I’d have lost $25K on them but due to hedging the original hedge I have a $24K open profit on the Unbalanced Condor.
Below you can see that the Greeks on my current SPX position is short 236 Deltas and that’s including the Apr Call Condor which is long 68 Deltas. It’s very important to notice however that my current SPX position is long over $19K in Theta which significantly helps to reduce my still rather large short Delta issue. Wait, what? Delta risk can be hedged by Theta? Partially yes! It’s not a perfect directional hedge but it sure helps if price moves relatively slowly against my short position.
Bottom line is I typically hedge a position with options instead of futures because those hedging options can also be hedged. Having multiple hedged positions in a portfolio can often lead to significant amounts of Theta being accrued which is more likely to lead to building profits then having mostly directional positions!
Let me know if you have questions.