Last update: August 2021
In Tagging the Golden Goose: A Lesson in Portfolio Protection we investigated the choices facing stock investors in search of protection. The whiz-bang idea for paying for the insurance policy (LEAPS puts) was to sell OTM call options every month or two. Those unexcited about the idea, but still open to additional strategies for curbing the onerous cost of buying LEAPS puts will be happy to know I have another tactic worth consideration.
Let’s recap the situation:
First: you have $100K invested in the S&P 500 via SPY. With SPY perched at $193.50 you own around 500 shares.
Second: To acquire protection you purchased five Jan 2017 175 strike put options for $1,000 apiece. The puts sit 10% OTM and provide protection for one year. All told you’re paying $5,000 or about 5% of your portfolio for the protection. As mentioned in the newsletter I’m not a fan of paying 5% of your portfolio to acquire puts every year. The cost is too burdensome.
Instead of selling covered calls to partially finance the put purchase, what else could we do? How about selling further OTM Jan 2017 puts? In other words, buy a put spread instead of straight puts. For example, what if we bought the Jan 2017 175 put for $10.00 while selling the Jan 145 put for $4.00.
The $4.00 received from the short put reduces the protection cost from $1,000 to $600 per contract. That’s a 40% reduction. The catch is that your protection now has a limit. The long 175 put locks in the right to sell your SPY shares at $175 affording protection down until the short put at $145. Essentially once SPY falls below $145 your insurance policy runs out and you’re back to full exposure. Here’s another way to think about it. The $175 put is 10% OTM so once the SPY drops 10% or more your protection kicks-in. The short 145 puts sits 25% OTM so if the market somehow drops more than 25% the protection disappears.
Risk graphs come in handy to illustrate the difference. First, checkout the long SPY position with the LEAPS put for protection. At expiration the put kicks-in at $175 to minimize any further loss. The downside is you now have to make $10 per share on the stock just to pay for the insurance.
The next risk graph shows the long SPY position with a Jan 175/145 put spread purchased for $6.00
Just like the prior position the long put kicks-in at $175 to eliminate any further loss from that point forward. Unlike the prior position, however, the protection only lasts until $145. At that point the short 145 put offsets the long put and you’re back to your straight long SPY position. What’s the upside for cutting off the protection like that? We received $4.00 from the short 145 put which cut the cost of our yearly insurance policy from $10 to $6 per share.
If you want the protection to go further, then don’t sell the 145 put. Maybe sell the Jan 135 strike instead. That won’t cut off the protection provided by the put spread until SPY has fallen 30%. Bear in mind this option includes a tradeoff. The 135 put is only worth $2.80, so it only reduces the portfolio protection to $7.20 from $10.00 instead of reducing it to $6.00. In the end you have to decide which lower strike put provides the optimal trade-off between cost and protection.
Given how uncommon it is for the SPY to fall 25% to 30% I certainly wouldn’t mind losing protection at that point in exchange for a 30% to 40% reduction to the annual cost of the insurance.
Tackle Trading Resources on Portfolio Protection
Continue learning about this powerful options strategy: Portfolio Protection. From free articles to Premium System and Trading Playbook, Tackle Trading has all the resources you need to MASTER this strategy like a PRO.
Portfolio Protection For Beginners [Free Articles]
Everyone invests. Everyone has money. Currency is a form of investment since the gold standard was removed from the currency system.
You’re a goose chaser. Admit it. It’s the gold you seek. And that’s okay. You’re in good company. Most of us round these parts have been searching for the big bird for ages. Some have even tagged one.
Come lear a Trick for Financing Portfolio Protection.
What is hedging? Come learn the basics in this 3-part series.
In part one of our new series on hedging, we defined precisely what the concept means. Today we’re turning to the why.
With a sound foundation on the what and why of hedging, we’re now ready to dissect the devil. Namely, when do I place my hedge?
The way that you go about hedging varies depending on what your strategy is. Come learn how to hedge a naughty naked put.
Today I want to talk a bit about the impact VIX spikes have on the cost of portfolio protection.
It’s nailing the management of Protective Puts that separates the men from the boys. Allow me to offer up a few ideas.
The bears are roaming. And while their sudden emergence likely spelled losses for traders far and wide, the pain doesn’t have to persist. I look at this as a “fool me once, shame on you; fool me twice, shame on me” situation.
Contrarians in a bear market seek signs of capitulation. Specifically, evidence that bulls are throwing in the towel and abandoning their once beloved positions.
Herein we explore the perks of lengthening your time horizon and embracing Long-term Investing.
Bear Market Survival Guide [Premium System]
Any investor can survive stock market crashes by using The Bear Market Survival Guide because it includes Wall Street’s best-kept secrets for portfolio protection.
Tackle Trading Playbook [FREE for PRO Members]
PRO Members now have unfettered access to the Tackle Coaches’ personal playbook containing thirty-one powerful trading strategies categorized according to the Options Greeks. Bullish, bearish, or neutral market conditions, this Playbook will help you dial up the right call more often and with greater confidence.
Financial freedom is a journey
Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.
Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.
All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.