Trading using hedging

[homer]

I'm all of a sudden interested in hedging. I know -- I've always believed in the passive investing via index fund, but I think I'm getting greedy.

(1) What book should I read? Are any books even worth it?

(2) Can an individual actually hedge efficiently with very little capital (no more than a few thousand)?

(3) Most importantly, is there any database (or data stream) of option prices that I can tip into to do data analysis? I wouldn't mind using some proprietary tool, but raw access to data would be best. If there are multiple such data sources, what is the cheapest?

(4) I am an idiot. I should just go back to passive investing. I know. I actually just want to do some offline data analysis and learn stuff. I probably won't really buy any options or futures.

 

[txeconomist]

Do you really have that much risk exposure? Buy buying futures or another highly leveraged derivative you may not really be "hedging." From your post above my guess is you would be doing quite teh opposite of hedging...insted of taking away risk...exposing yourself to more.

 

[homer]

Sorry, my initial post may not have been extremely clear.

I have no positions in options or futures.

I am contemplating entering the F and O marketplace, via hedging. However, I need to learn -- and learn a lot before I would be comfortable executing a single trade.

For that, I want to acquire data and play around with some base strategies for hedging. Obviously, my plan is to develop some of my own strategies, test them using historic data, and then go to bat.

I just need someone to point me to the right direction -- by answering the questions I listed (and any other general advice).

 

[froghorn717]

First off I am not entirely convinced you know what you are trying to accomplish.

Merely trading derivatives is not hedging, they are tools that can be used to hedge risk, as txeconomist was alluding to. On top of that, when you hedge a position, your entire position may make money but the "hedge" part by definition should lose money (i.e. long call short stock on a ratio but if positioned correctly you will make more than you lose, taking into account you didn’t overpay for the lower gamma higher Vega..this is further assuming all variables staying constant...in this scenario one would be more likely to dynamically re-hedge the position by buying and selling the underlying based on the delta of the option.)

You need to be very well versed in how the instrument you use reacts to the underlying position you are trying to hedge risk out of.

Further are you trying to hedge market risk(options/futures/forwards), credit risk(CDS), interest rate risk(interest rate swaps), possibly forex risk(currency forwards/futures/options) or volatility risk(options or variance swaps)?

So let’s start with what you are trying to accomplish then go from there because initially looking at your post it looks like you are itching to speculate. It may just be a terminology issue, but either way you need to be very well versed in finance, the machinations of the market(such as counterparty risk, correlation, and how to reasonably value a derivative.)

You need to understand how the underlying influences the derivative and vice versa...

for instance you need to know what happens when a large gorilla fund is buying/selling derivatives in size, and how that impacts your position and the rest of the market.

so I guess to hedge risk as an individual depending on the amount of capital you have and your understanding of risk, sure it makes sense. As an individual looking to speculate using options, furtures, forwards, or swaps...i would say not a good idea.

Yes I do this for a living for an IB...

 

[txeconomist]

I agree with frog that you probably want to speculate and not hedge.

I think that it’s probably also worth mentioning that if your income/ net worth / investing experience is insufficient, you will not be given the opportunity to trade leveraged derivatives.

As far as question #2. probably not, but Id say options would be the cheapest due to the lack of margin and maintenance. Ive been wrong before though, a lot actually.

 

[Bookman]

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[fratboy_legend]

the first thing you should do is look at what you own and decide which risk(s) you want to remove from it. once that is laid out, removing that risk is pretty straightforward.

keep in mind, if your long side is simply an index fund, there are a lot of risks you can remove by just tweaking that side of the book and forgoing the short side altogether.

Index funds, and their associated options, are a relatively cheap, easy to understand tool for removing risk from a more concentrated portfolio

 

[fratboy_legend]

i just re-read your post title and assume you mean INVESTING using hedging. is that correct?

 

[jimmyjazz]

Question for the hedge experts: a lot of people have most of their money "invested" in real estate. How do you hedge against that?

 

[froghorn717]

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[homer]

Sorry for the rampant confusion.

I am in fact trying to hedge -- not speculate. I want to reduce my risks (in whatever securities I have a long position in) and use options as de facto leverage. Note that the whole "hedging experiment" will be independent of my index fund holdings (so the advice for hedging against index fund holdings does not apply here). In other words, I have earmarked a small set of money to experiment inside the world of hedging.

I want to learn how to hedge. I have no clue how to. I understand the basic notion. But, are there are any good books that give you a walk through about some basic strategies and techniques to implement while hedging? Should I focus on a specific sector? etc.

Maybe, you guys are right -- I am not experienced enough (or rich enough) and even my intuition says it is not a good idea. However, I am completely willing to lose a few thousand dollars to learn (to make money or to learn a lesson).