Experts guide to Tail Risk Hedging
How to hedge your trading portfolio
Here’s a playbook of cost-efficient downside tail-risk hedges (SPX examples, but transferable). I’ll keep it practical: what to buy/sell, where to place strikes, how it behaves, and the trade-offs.
.In my notes:
The percentages (e.g., -5%, -10%, -20%) mean distance from spot (moneyness or ATM)—i.e., strikes set X% below the current index level.
You can also target by delta (option sensitivity). Many pros do this because delta automatically adapts to time/vol.
Here’s a quick rule-of-thumb mapping (SPX, typical IV, no crisis). These are approximate—delta shifts with DTE and vol:
How to use this table:
If I wrote “buy a put around -10%,” that’s roughly a 15–20 delta put at ~45 DTE (a bit higher delta if you go farther out in time).
“Deep OTM” LEAPS like -20% to -35% are typically 5–10 delta (or smaller) depending on tenor.
For 1x2 backspreads, a common target is short ~30–35Δ / long ~18–22Δ (often near -5% / -10% moneyness at ~45 DTE).
For broken-wing flies, think long ~30–40Δ / short ~15–20Δ / tail ~5–10Δ—which often lines up with something like -5% / -10–12% / -20%.
If you prefer to run purely by delta (recommended):
Moderate drawdown hedge: anchor longs near 20–25Δ.
Crash/tail: anchor longs near 5–10Δ (LEAPS or extra wing).
Financing shorts: keep them safely higher delta than your longs (e.g., short 30–40Δ against long ~20Δ), and manage/roll if spot tags the short.
Here are the STRATEGIES:
1) Deep OTM Put Fly (Broken-Wing optional)
Setup: Buy 1 put ~-5% to -8% (K1), sell 2 puts ~-12% (K2), buy 1 put ~-20% (K3). 30–90 DTE.
Why cheap: Two shorts finance the wings; net debit is small.
Tail behavior: Limited max payoff centered near K2; still protects a fast gap down if you use a broken wing (widen K2→K3) for extra tail.
Risk: If selloff stalls right at the short strike, payoff capped; mild dips may under-hedge.
2) 1x2 Put Backspread (for zero/credit entry) Our favorite !!
Setup: Sell 1 put ~-5% (K1), buy 2 puts ~-10% (K2). Aim for near-zero or small credit; 30–60 DTE.
Why cheap: The short closer-to-money put finances two tails.
Tail behavior: Explodes to the downside (long convexity) once below K2.
Risk: Between K1 and K2 on expiration you can lose money; manage/roll if spot hovers in that zone.
3) Put Diagonal/Calendar Hedge
Setup: Buy a long-dated deep OTM put (ex: 6–12M, -15% to -25%); sell shorter-dated (weekly/biweekly) higher strikes (-5% to -10%) against it on a roll.
Why cheap: The regular short-premium harvest offsets carry while preserving long-dated crash convexity.
Tail behavior: Big gap moves expand the long-dated put; your short expires soon so risk is bounded by active management.
Risk: Needs discipline: cut/roll short legs on vol spikes or if spot speeds toward short strike.
4) Put Spread Ladder (Debit-light, tail kept)
Setup: Buy put ~ATM/-3% (K1), sell put ~-8% (K2), buy extra deep OTM put ~-20% (K3). 45–75 DTE.
Why cheap: The K1–K2 vertical funds part of the K3 “disaster” wing.
Tail behavior: Solid coverage through moderate drops plus a second kick on a crash.
Risk: Less protection if we grind lower slowly; structure size matters.
5) Collar-Seagull (fund the put with a call sale)
Setup: Own equities → Buy put ~-7% (K1); sell call ~+5% (C1) and sell a far OTM put ~-20% (K2) to further cut cost (that’s the “seagull”).
Why cheap: Two shorts can reduce put cost to near zero.
Tail behavior: Good protection down to K2; after K2 you’re naked again—use small size or keep K2 very far.
Risk: Capped upside; exposure resumes below the extra short put.
6) VIX Call or Call-Spread Overlay
Setup: Buy VIX 25–35 calls or 1x2 call spreads 30–90 DTE (e.g., buy 25C/sell 35C, or buy 1× sell 2 further OTM to reduce cost).
Why cheap: VIX options can be inexpensive when term structure is in contango; they spike on stress.
Tail behavior: Explosive on gap-down/vol events; diversifies model risk vs only owning equity puts.
Risk: Path dependent; can decay if selloffs are slow and muted in vol.
7) Treasury (Rates) Crash Proxy via Calls
Setup: Buy calls (or call spreads) on TY/ZN futures or TLT, 60–120 DTE, small debit.
Why cheap: Rates vol can be lower than equity skew; crisis often sees flight-to-quality.
Tail behavior: Equity drawdown often → bond rally → hedge pays.
Risk: Not all selloffs see rates rally (inflationary shocks); use as complement, not sole hedge.
8) Long-Dated Deep OTM Puts (LEAPS tails)
Setup: 9–18M tenor, strikes -20% to -35%, tiny notional (0.3–1.0% portfolio per year).
Why cheap: Low theta per day and very convex.
Tail behavior: Big pop on regime change/crash.
Risk: Dead money in benign regimes—budget it like “insurance.”
9) Event-Window ATM Put Sniping
Setup: Buy 1–3 week ATM puts into known macro windows (CPI/Fed/geopolitical risk), then monetize on vol pop or delta move.
Why cheap: Short time spent long theta; you’re targeting moments when skew underprices near-term gap risk.
Risk: Timing risk; need a repeatable calendar/process.
How to Choose & Combine (cost vs. convexity)
Budget: Allocate ~0.5%–2.0% of portfolio per quarter to hedging; pre-commit so you don’t chase after the drop.
Blend: Common robust mix:
40% long-dated deep OTM puts (structural tail)
30% VIX call spreads (shock-vol)
30% 1x2 put backspreads or broken-wing flies (cheap convexity)
Tenor staggering: Ladder maturities (e.g., 45D, 90D, 180D) so you always have some gamma and some vega.
Practical SPX Anchors (example starting points)
Broken-Wing Fly (60 DTE): Buy 1 × 0.95 put, sell 2 × 0.88, buy 1 × 0.78; target ≤ 0.40% portfolio debit.
1x2 Backspread (45 DTE): Sell 1 × 0.95 put, buy 2 × 0.90; aim for small credit to carry.
Diagonal: Long 12-month 0.80 put; weekly roll short 0.95–0.92 puts for income (auto-reduce/suspend shorts if VIX > 28 or spot breaches 0.96).
Execution & Risk Rules (the part most people skip)
Enter on cheap vol: Add when 1–3M IV is in its bottom 20–30% of the past year and skew is steep (puts cheaper per delta of tail convexity).
Position limits: Size so max loss on spreads/backspreads at their worst spot is ≤ 0.5–1% portfolio.
Trigger-rolls:
If spot tags your short strike on a ratio/diagonal, roll down/out the short immediately (keep convexity).
If VIX spikes > +8 pts in 48h, take partial profits on VIX calls/short-dated puts.
Don’t over-sell: Short legs are financing tools, not P/L centers. Keep margin of safety (distance and time).
Document the plan: Pre-write what you’ll do for (a) -5% quick dip, (b) -10% week, (c) gap ≥ -3% overnight.
Quick Pros/Cons Matrix
Cheapest carry: 1x2 backspreads, broken-wing flies, collars/seagulls.
Most convex tail: Deep OTM LEAPS puts, 1x2 backspreads (once through long strike), VIX calls.
Best all-weather mix: Diagonal put hedge + periodic VIX call spreads + a little deep-OTM LEAPS.
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