Monday, July 29, 2013

What amount of Delta adjustment should be used to hedge portfolio

It's always an interesting question for me regarding how many Delta adjustments been used to hedge my option income portfolio.

Should it be bull market or bear market condition dependent or should we always try to adjust to neutral Delta? I had a question posted in Feb 16, 2013: Does it make sense to adjust to a more Delta  for each adjustment if the adjustment is following the current market trend? Obviously, I have not been prepared to answer this question as of now.

The main reason that preventing me from a total neutral Delta adjustment is that there is always a possibility of market to reverse back, reducing original profit potential to some degree that is dependent on the Delta value adjusted.

If the Delta adjustment is not enough, continued Delta adjustments are required as market follows its force of inertia. This creates frustration in trader's mind and demands extra time for portfolio management. It happened in my trading in July this year.

If the Delta adjustment is large enough to make the hedged portfolio Delta neutral, there is a possibility of market reversal and associated Delta re-adjustment in order to maintain proper portfolio Greek values. The previous color-coded chart seems to be useful to identify this scenario or adjustments vs market reverses. In the week of last Oct. 15, there was an IC roll up adjustment. The adjustment changed Delta by 5 points only. After the adjustment, the market reversed.

It seems to me more neutralized Delta may be better if market sentiment line is not in overbought/oversold zones (80 < MS < 20). Otherwise, smaller Delta adjustments may be better due to the likelihood of market reversal.

Due to limited time today, I will update more thoughts on this one in the future.

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