Volatility Tweaks on the GULL

Fifty Ways to Trade an Option

The world’s most popular options strategy is a three legged hedge. 

While covered calls reign supreme for most retail investors, at an institutional level there are tens of billions of dollars that trade a hedged equity strategy every quarter.

This clever portfolio management tool converts potential energy into protection, buying a defensive put spread by selling away upside gains via calls. Cash neutral is the most common way to do this, where you pay nothing up front and only need to swap outcomes. 

To keep it $0 debit or credit, you must fix one side first and adjust the other to match. Most often we take the cost of our desired levels of protection, and find the call that offsets it. The opposite also works however, where we can stake out a piece of upside and reverse engineer how much protection this gets us. 

As with all overlay strategies, this will dampen the performance of the underlying asset. Anything that covers a long stock position with short options will reduce the outcome space. And most investors are happy to do exactly that - hedged equity is about capturing some of the gains and cashflow of the stock, without all the chop. 

The question then becomes, what is the right amount of offset? It’s both a personal question about risk tolerance, but also an adjustment that should be made based on the volatility environment and characteristics of the underlying asset. 

The standard target used by the large institution trading this is a 5%/20% out of the money put spread each quarter. That’s also the basis for the GULL indicator calculation we use at Harvested and in TheTape.Report. Over time the value of that put spread in call space changes based on absolute volatility levels, but also the skew relationship between calls and puts. 

In SPY we’ve remained fairly stable over the last 3 months, though early August saw elevated levels during the volatility spike. 

NVDA has followed a similar pattern, but note the absolute levels here - the fixed 5/20% put spread gets you more than 3x as much upside in the chip maker. 

The difference between these two means we need to adapt our GULL Hedged Equity strategy for various underlying stocks. At Harvested - in addition to tranching out over multiple expirations,  our AutoGULL systematically adjusts the protection levels. Options strategies have to adapt. 

Today in Fifty Ways to Trade an Option, we’ll be exploring how to think about adjustments to the GULL strategy for different underlyings and market environments. 

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