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Call Options for Hedging – FWOT

Like the great herd of sheep like morons you read about in the financial press and blogosphere I am currently short volatility having only discovered the trade last year. As a Johnny Come Lately (as usual) I have spent many weeks looking into protecting my long position in the inverse volatility ETF XIV with various hedging methods.

I have already written a post on hedging it with TMF which has been highly successful so far but will undoubtedly let me down at some crucial point in the future.

I then turned to options and bought VIX data from CBOE.  I have spent weeks cleaning up the messy and badly presented data and then turned to writing a back testing program in Python/Pandas to back test various option strategies.

I had never bothered much with options before partly because I was put off by the ridiculous names people give to their various strategies and partly because the largely useless “greeks” were all greek to me, and in any event have absolutely no predictive value whatsoever.

Here is the punchline: protecting your position with long call options is a FWOT unless you are an expert in market timing and know exactly when to put the hedge on. If you are permanently long puts you will destroy your returns with the huge cost of the option premiums. And if you think you can time markets save yourself the bother and expense of options and simply exit you short volatility position.  

Having disappeared down the options rabbit hole for a couple of months I am now absolutely staggered by the sheer bloody nonsense out there  and the plethora of stupid or dishonest sharks peddling schemes to the hapless fools seeking Eldorado.

It is particularly interesting to see that all the CBOE indices involve selling options not buying them. Option selling is not without its huge perils but compared to option buying it is the holy grail – which is actually damning the practice with faint praise.

As anyone who has bothered to do any back testing with be aware, option selling can be every bit of much as a disaster as option buying.

So why, in the name of god, is there an entire vast industry out there built around option trading? The only answer has to be “because there are a lot of bloody fools who think they have discovered the philosopher’s Stone”.

I have almost come to the end of my option Odyssey but my last vague interest is in back testing The CBOE S&P 500 Range Bound Premium Income Index Series . It looks interesting prima facie but as is usual with any trading scheme scheme it relies on historic data to predict the future (in this case the historical volatility of the S&P 500).

I will report further but suspect that a promising idea will turn out to be an over optimistic chimera.

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