How to hedge a trade

BY ANDREW GIOVINAZZI

April 24, 2024

Yo Pit Crazies,

If you have not signed up for the Option Pit Summer Extravaganza in Chicago, do so now.

The drop in VIX has been stunning over the last several days. From a peak of 21.5% to just under 16% now has traders shaking their heads. The reality is Geopolitical Issues are tough to price so traders jack up the volatility until the crisis passes.

VIX hitting the floor is one thing but we are still in Zone 2. A couple of weeks ago in early April VIX had a sharp pop as it was near the bottom of Zone 2 (VIX 13-17.99). That pop was the end of the inflation dream with rates coming in. I don’t see anyone serious thinking the Fed can cut rates with inflation deltas heading upward again. We are also not in full panic mode either. VIX still has a foot in both worlds.

3 month VIX Chart

If VIX futures can go from 16 to 12, that is a 25% drop. VIX cash just dropped from 21 to 16.

That means products connected to those futures can drop in kind. I think it is still a day or two early for the naked Proshares Ultra VIX short term futures ETF (Ticker: UVXY) trade. When you might be early, hedge a little.

So I came up with a hedged variation in The Trading Desk.

How to hedge a trade.

I bought 3 UVXY May17 33 puts for 2.24

Buying puts outright can get a little tricky in a vol product prior to a contango VIX curve. That is the #1 reason we have held off in 0DTE and Trading Desk.

The reason being UVXY is not decaying so $ made comes from a drop in VIX cash. What I call a shock move. The issue is if the market decides to change its mind, which is what a flat VIX curve means, the UVXY puts could go up in smoke. So I needed to devise a short term hedge.

To me a hedge means get me out for break even on the trade and live to fight another day. I took the recent lows of the SPDR S&P 500 Trust (Ticker: SPY) and set up my hedge to pay there. I bought the SPY May03 495 puts for 1.88. The ratio was 1 SPY put to 3 UVXY puts. If the vol crush that is underway comes to pass, I should make $250 per 1 x 3 ratio. If SPY loses the plot to Friday’s low, I am out for scratch.

SPY 3 month chart

I expect to be out of this trade by Friday of this week. The hedge allows me to hold a little bigger of a position overnight. I also need to be prepared to close it if the SPY puts start to pay. Always Be Closing ABC.

Oh boy, the next few days should be exciting.

To Your Trading Success,

-AG