WRITING TRADED OPTIONS for income

Biffer

Unfortunately Natenburg isn't alot of use with this strategy. In fact, there is very little written material on the subject.

On the question of hedging with long ESX my thinking was this;

Assume correlation of +1 in the basket
Assume correlation of +0.5 in the remainder of the index stocks.


Assume all of these basket stocks correlate +1 and all rise by 10%, the losses would look like this;

Basket
.......Price.......Weight...ATM ShortCalls...Loss +10%

Stock A 650.........10%..........10...........-6500

Stock B 500.........10%..........13...........-6500

Stock C 450.........2.5%..........4...........-1800

Stock D 480.........2.5%..........4...........-1920


....................25%.................Total -16,720

The rise in the basket will cause the FTSE to rise by (25% x 10%) 2.5%. Now the question is what will the rest (75%) of the index stocks do ?

I assumed +0.5 correlation so assumed everything else rises by 5% (on average) which will cause the index to rise by (5% x 75%) 3.75% added to the 2.5% making a total index rise of 6.25%.

With the index trading at 5525 that 6.25% equates to a 345 points index rise, so to cover the loss I’d need to go long by (16720 / 345) £ 48 per point, or roughly 5 contracts.

You could be more (less) cautious by assuming less (more) correlation.

Any thoughts ?