The Hedge STT is a trade whose primary role is to hedge for a normal downside move. It is not typically considered an income trade, although some people have chosen to trade it that way. If the markets are neutral to bearish, then it can be a viable income trade, but it's not going to produce income when the markets are bullish (although it's not really going to lose hardly anything either).
The key thing to note, as you'll hear me describe very clearly in the above two presentations is that although the Hedge STT is great as a downside hedge for a normal downside move, it is NOT designed as a hedge for a Black Swan event. I have a separate trade called the Black Swan Hedge (BSH), which I teach within the Portfolio Margin and SPAN Margin Trading Tactics course, which is specifically built to protect against Blacks Swans.
Although teenies (out-of-the-money long puts) are typically used by traders to protect against a Black Swan event, I recently wrote a blog post showing how the Black Swan Hedge (BSH) tends to produce around twice the profits when compared to using teenies, even though you spend the exact same amount on the hedge.
Some people have been looking into this Hedge STT and have made two mistakes:
1) not setting up the Hedge STT correctly
2) thinking that the Hedge STT should protect against a Black Swan event
Proper setup of the Hedge STT
The Hedge STT starts off with slightly negative deltas upon initiation:
I have starting deltas of -1, and note how the T+0 line starts off completely flat (horizontal) all the way to the start of the structure.
This trade makes great use of portfolio margin; notice how the portfolio margin for this trade is only $1.1K.
After 30 days, we'll start seeing a profit hump build up:
After 60 days, the profit hump will start looking very nice:
As the trade ages, the downside profit hump gets bigger and bigger.
Once the back wing of the HSTT is harvested (I explain this concept in the above two presentations), then you can end up with a trade that looks like this (that's a screenshot from one of my live trades):
So you can see that the HSTT can provide some very nice downside protection for a grind down type of market while in the standard (put condor) configuration, and once you have harvested the back wing during the final few weeks then the trade can provide even stronger downside protection.
Now let's go back to the original starting config for this trade, as soon as it is initiated:
Again, notice how we start off the trade with flat to slightly negative deltas.
I recently came across a blog post by a user who was trying to evaluate the effectiveness of the HSTT, but unfortunately he had configured it like this:
Notice that this trade has been started with positive 2.46 deltas, and just by looking at the risk graph (and comparing it to mine) you should be able to tell that this setup is nothing like what I recommend for the Hedge STT.
The user then goes on to show that the STT “didn't work” during the Aug 24, 2015 crash.
That shouldn't come as a surprise, since:
a) the Hedge STT wasn't configured correctly
b) the trade was not designed to hedge against a Black Swan event
Hedge STT setup on Aug 12, 2015
Although the Hedge STT was not designed as a hedge for a Black Swan event, at this point you're likely curious to know how a properly constructed Hedge STT ended up doing during the crash.
Here's a proper setup on Aug 12, 2015:
Status on Aug 21, 2015
Let's start by taking a look at the price action on Aug 21, 2015 and also the volatility levels:
That's some nasty price and volatility action. Apart from the big and violent drop in SPX, the IV went from 13 to 26 (black plotted line).
That's definitely not a normal grind down market.
So is our Hedge STT getting killed?
Let's have a look:
Even though we've had a nasty and violent price drop and quite significant increase in IV, the HSTT is still holding up just fine. It's still up $90, even though the trade didn't have a chance to start building up the profit hump, since this big move down happened just 9 days after initiating the trade. You therefore have plenty of opportunity to exit this trade on Aug 21, 2015 for essentially even money.
Status on Aug 24, 2015
Let's assume that, for whatever reason, we weren't able to exit the trade on Aug 21 and decided to stay in the trade.
That's when Aug 24 comes along and gives us this:
Yet another violent down day, and now IV jumps up by another 12 points and is now at 38.
Here is the HSTT:
It's down -$940, which actually isn't that big of a loss, since this trade can tend to make around $400 to $500 or so pretty easily in a neutral to grind down market. And remember that we had plenty of opportunity to get out on Aug 21 for even money.
The very next day, on Aug 26, the trade is back to a loss of just -$280:
Remember that we don't expect the Hedge STT to make money during a Black Swan event. It is not designed for that; it's designed for a neutral to grind down market.
In order to hedge against a Black Swan event, we would use the Black Swan Hedge trade instead.
You can therefore leverage two types of hedges:
a) the Hedge STT for a normal downside move, in a grind down market
b) the Black Swan Hedge, which hedges against Black Swan events
Both of these hedges, as well as income versions of STTs, and other trades are taught within the Portfolio Margin and SPAN Margin Trading Tactics course.