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Jurassic


Total Posts: 221
Joined: Mar 2018
 
Posted: 2018-11-11 20:27
What is more risky: selling calls or selling puts (say on SPX)?

Does this change if it is delta hedged?

nikol


Total Posts: 712
Joined: Jun 2005
 
Posted: 2018-11-11 21:56
Selling call is more risky due to unlimited potential exposure. Exposure on short puts has a ceiling.

First order approximation: hedging makes both positions equally risky

Second order: hedging short puts requires shorting underlying, which might be expensive to borrow, i.e. leaving you with borrowing rate risk, which might be significant.

PS. When underwriter issues option on himself, it is a bit different story. They are called warrants.

FDAXHunter
Founding Member

Total Posts: 8372
Joined: Mar 2004
 
Posted: 2018-11-12 08:40
Define risky. Maximum possible loss? VaR? And how often are we delta hedging? Just once? Or more than once?

Under the max loss scenario, Nikol is correct.
Technically you have some underlying assets where you'd have to answer the question the other way around, for example interest rate futures using the IMM index construction (100 - rate).
Here selling calls would be considered to have more limited downside (in a max loss sense) than selling puts. But you used SPX as an example, so this doesn't apply.

If your definition of risk is more along the lines of volatility of P/L (VaR) I would say that to a first order approximation both are almost equally risky (the order of magnitude of volatility on SPX is 15%, not 150%).
There is volatility skew for most underlying assets (including SPX) which, amongst other things, implies that the price exploding upwards is less than exploding downwards.

Using the volatility skew you could argue that out-of-the-money puts are more risky than out-of-the-money calls in assets where the skew is negative. Like SPX.

Mind you, subject to the caveat that nikol already mentioned about borrow (which you can even lock in until the expiration of your option) and some other technicalities, a call can be converted into a put and vice versa.

The Figs Protocol.

nikol


Total Posts: 712
Joined: Jun 2005
 
Posted: 2018-11-12 12:06
To add about initial specs which are incomplete.
If it is about binary options, then both are equally risky even without hedging.

By the way, asking those correct questions is also part of the interview.

ronin


Total Posts: 454
Joined: May 2006
 
Posted: 2018-11-12 12:18
@jurassic,

This is an open-ended question and it is giving you an opportunity to demonstrate how much you understand about options and risk.

Whoever asked you that isn't looking for a one-word answer.

"There is a SIX am?" -- Arthur

Jurassic


Total Posts: 221
Joined: Mar 2018
 
Posted: 2018-11-12 14:11
@ronin Ok granted.

I thought the answer would be to sell put and not calls (because of the potential unlimited liability)

Im convinced Ive seen this question somewhere else there is something to do with if you are delta hedged you can end up out of the money for the option and the wrong way round on the delta as well.

nikol


Total Posts: 712
Joined: Jun 2005
 
Posted: 2018-11-12 15:35
be aware:
term "wrong way" is usually used to describe risk of buying instrument from counterpart who is also underlying to this instrument

watch your language - it might cost your employers big money.

ronin


Total Posts: 454
Joined: May 2006
 
Posted: 2018-11-12 18:52
If you are delta hedged, there is no difference between calls and puts, modulo issues with shorting a single stock as per @nikol's answer.

What you remember is about vega. The skew follows the forward, so if the underlying goes up, your put loses on delta (because it goes out of money), but it gains on vega (because your strike is now in the left wing and left wing volatility is higher). It's the opposite with calls, but it depends on the shape of the call skew. It's a convexity term you have to account for in the delta hedge.

About unlimited liability, I can only quote Jim Chanos: “I’ve seen more stocks go to zero than infinity.”


"There is a SIX am?" -- Arthur

Strange


Total Posts: 1551
Joined: Jun 2004
 
Posted: 2018-11-13 05:20
Like almost every other question in finance, it's simple and yet at an advanced level incredibly complex. Once you start talking various real life example, there is a bunch of stuff to consider. Once you consider these things, there is a bunch more.

I don't interest myself in 'why?'. I think more often in terms of 'when?'...sometimes 'where?'. And always how much?'

ronin


Total Posts: 454
Joined: May 2006
 
Posted: 2018-11-13 15:22
What @strange said.

Of course @jurassic, there is a big chance you are being asked that question by some HR drone or even a robot in some drive to cut recruiting costs. Who knows what answer they have on their cheat sheet.

In which case, this: Yes Lisa, Daddy is a teacher

"There is a SIX am?" -- Arthur
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