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  • Hedging with a synthetic stock position

    October 5, 2009 by  
    Filed under Hedging, Options

    Q: You discuss hedging SRS with a synthetic stock position in IYR. My question is why not do a short synthetic position in SRS, Sell call and buy puts. I have noticed people in the TOS chat room talking about shorting AIG this way versus borrowing stock to short. This way you would have along and short position in the same stock. thanks in advance.

    A: AIG is a different story because there is no corresponding ‘short’ AIG etf with calls and puts. So your only hedging option is to sell calls and buy puts.

    There are 4 reasons I’m using IYR to hedge instead of a collar (a “collar” is ‘selling calls and ‘buying puts’ on a stock you own) on SRS:

    1) If I sell calls on SRS they can take my stock away if srs surges and they are in-the-money thereby losing my position that I was able to purchase at much lower prices.

    2) If my puts on IYR are assigned I have long IYR stock which is a hedge in itself – it’s equivalent to having a deep -in-the-money put on SRS. It does require more margin however.

    3) IYR and SRS are very tightly correlated – srs is exactly 2X the move of IYR.
    I know ahead of time what my exact risk is and I can scale in or out and be long or short my hedge by simply adding a few contracts.

    4) The theta is positive (I set it up so that the option I sold is slightly higher in price than the one I bought) so I collect money if the stocks do nothing.

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