In underlyings with high IVR and a neutral assumption, we often prefer to sell undefined risk positions, such as Strangles or Straddles. However, directional risks and volatility expansion still threaten our potential success in the trade. Today, Tom and Tony demonstrate multiple ways to hedge short premium plays against three different risks.
Hedging Delta
Oftentimes, we set up strangles and straddles to be delta neutral positions, but, as underlyings move, the short options can pick up delta quickly. To hedge short (long) delta, traders can purchase (sell) static delta in the form of shares, or they can roll the untested side of their position to flatten out their directional exposure.
Hedging Realized Volatility
As short options near expiration, gamma risk picks up, meaning that large swings in our daily P/L can occur. In order to avoid gamma risk in short premium plays, we tend to manage winning positions early, taking profits off the table. Additionally, rather than short premium in SPY, traders can sell Call spreads in VIX to remove their exposure to realized vol.
Hedging Implied Volatility
Due to the inverse relationship of VIX to the S&P 500, traders who sell premium in SPY can also get long volatility products (potentially using futures, Covered Call Strategies, etc.) while still benefiting from the theta decay in their naked Straddle or Strangle.
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