Stock exchange news, options. Delta neutral hedging is a strategy that consists of options and basic asset. There exist option-buying and option-selling types of delta neutral strategies.
The latter presupposes gaining the most from selling an option, provided that basic asset position is the starting point of hedging price risk in opposite direction. When the position stops being neutral to the market, we perform rehedging by means of basic asset. So, what is the trouble of short-term delta neutral position? The trouble is that every episode of rehedging may result in loss.
However, time value decay of the option should cover the loss from rehedging transactions. This brings up the question: how to perform rehedging with minimal loss, as theoretically there may arise a situation when loss from rehedging exceeds time value decay of options. In other words, it would be good to do no rehedging, but here arises the risk of gaining even higher loss, having lost neutrality to the market.
What is to be done? This is a difficult question, and it resolves into the fact that rehedging is to be rationalized to the maximal point, so that there are no needless transactions. Let us see how this can be done at the example of USD/JPY currency pair. On June 15 there was open a delta neutral structure, consisting of short 1038-dollar put option, with USD/JPY hedging position at 0.5 lot. On June 18 delta rehedging has been held (option delta has changed to 0.6)
On June 19 the position was slightly negative (-70 dollars), as total option loss exceeded total spot gain. 20% profit is the strategic target, and a position is to be quit when it is reached. On June 20 asset price was at the point of final hedge
and our position is slightly becoming positive due to falling volatility and time value decay of sold option
Coming closer to American trading session, we faced strong movement, which made us balance the position neutrality. In other words, we were obliged to buy 0.1 lot at the point of 79.68; in such circumstances we lost 120 dollars from our profit. With hand on heart, this hedge is not the best one, and it has been dictated by emotions. The question is whether it could have been avoided, taking into consideration the fact that hedge has been done at the peak of pin bar, as the picture below shows:
One way or another, analysis can be done in the following directions: 1) as has been stated by the Analytics Team of Commodity Trading Department, Japanese yen is a technical currency, and it is very good at working out at various levels; it is not worse than EUR, which is no wonder wonder, for trading volume of JPY is rather high, standing down to EUR only.
According to the Analytics Team of Commodity Trading Department of , the picture shows that upper levels have been designed by the zones of support/resistance, and that pin bar of rehedge has stricken into such level, which has served the basis for a pullback. Moreover, having a closer look at the picture, one can see the chart of JPY future, which enables to trace trading volumes.
In this reference, volumes also provide much information. Volume splash is seen at the marked bars, which may mean that a large-scale gambler is moving to the opposite direction, taking into consideration the pattern of these bars.
In other words, one should admit that point of rehedging has been dictated by emotions, which has proved to be incorrect technically. We sincerely hope that the market will forgive us this mistake.
So, what makes analysis and decision-making process difficult while trading a sold option with basic asset rehedging? The matter is that the zone of waiting and performing the transaction is hard to identify psychologically, much harder than the point of entry into a certain position in order to gain profit. This is similar to driving a car by looking into rear-view mirrors only. However, one can get used to it and become a professional.
