I started working on 2 new algos, but I wanted to ask what are some of the issues w/this strategy before I dive head first. I'm new to options / hedging, so please if I sound like a complete turd, please be gentle (don't flush just yet! ;P) I'm still not too familiar with how options work so i may sound foolish (i might be just re-iterating some well known trading strategy)
1) hedge longs w/put options (and vice versa, shorts w/call options).
As such, I am seeking volatility, so I would look for high beta stocks. I would look for (reverse directional) option either in that stock, or in some other correlated asset like SPY / QQQ. If directional bet is correct by the time of option expiration, let option expire and close out the directional bet. If not, close out both positions.
I got to thinking.. why even bother buying stocks? Might as well just go options in both directions. But I guess something about this just seems.. unsound. But I'd love to hear why.
2) other than brute force, how do you look for pairs that are candidates for long/short strategy?
My initial understanding was that you are looking for some inherent relationship between the two.. such as
- competitors of same sector
- buyer / supplier
- connected via insider
- (Some other unknown method?)
which can be all mined via entity relationship extraction.
And even if you do determine this relationship, how would you determine that the relationship would actually be forward looking? (i.e predictive)
3) Are there other hedging mechanisms that I'm not aware of?
Ok I lied.. so 3 part question.