Hedging strategies - Do they really work for American Type options

#1
Hi

I am new to options. I am wondering if hedging strategies really work for American type options. Consider the following scenario.

Sell SBI PUT : 1800
Buy SBI PUT :1600
CMP of SBI as on 02-Dec : 2000

With this trade i calculate the max risk as Rs 200 (1800-1600).
Assume that SBI drops to 1500 (closing price) on 03-Dec and my Sell PUT option is assigned . So my loss now is 300. So i decide to exercise my Buy option but i can do it only on 04-Dec as i came to know about assignment after market close.
However SBI rebounds to Rs 1900 and closes at that price on 04-Dec and so my exercise is rejected. So my loss is 300 which is more than what i expected (200).

It appears to me that hedging strategies may not work for American type options due to time delay in exercising hedging options.

Any thoughts?


Raj
 

AW10

Well-Known Member
#2
In my view, you are right. In such cases, we do carry overnight risk of price movement cause we can take action only on next day to excercise our right.

In reality, there is typical range of price movement in a day. There are hardly 000.1% chance that SBI may jump from 1500 to 1900 in 1 day. If we look at historical price trend, we can get fair idea about such overnight risk.

Happy Trading
 

Capricorn

Well-Known Member
#3
From a trading perspective , you would be better off managing the hedges dynamically. Instead of waiting for assignment to book profit on the hedge it should be done routinely as soon as the hedging option becomes itm, then Roll down for another atm/otm option as the hedge for overnight positions. Cheers.
 

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