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| quote: | Originally posted by tvmann
Well I'm no options trader so I'm not up to speed on this stuff, but I was thinking of the probably typical situation where someone has big gains in a stock (say 100%) and wants to try to protect the gains by having some PUTs, just a simple "insurance" strategy, as an alternative to stop-loss orders that burned people who sold low in the 1 hour melt-down. |
I rarely say this when it comes to options, but you're kind of overanalyzing.
Option costs are composed of an intrinsic value (how deep in the money) and a time value (premium). When you buy protective puts, you treat the premium as a sunk cost. It's insurance.
For example, I've owned a bunch of PCX shares for several months now. After last month's options expiration, I bought $20 puts (when the PPS was $22). I paid "something" for each contract - a very small amount compared to the cost of 100 shares - it doesn't really matter what.
Now, when I bought those options, the PPS was at about $22. Holding the puts capped my maximum loss at $2 per share. The PPS is now below $20, but the puts give me the ability to sell them at $20 regardless. At this point, it does not matter whether the price holds at $19 or falls to $10. My shares have a delta of 1, the puts have a delta of approximately 1 (because they are ITM), so no matter where the price swings between $0 and $20, I don't lose or gain any value on the combined position of the shares + puts.
You don't sell or execute a "protective" put unless you want to exit the position or you are rolling over to the next month's contract. Otherwise it's not a hedge anymore, it's speculation, and you might as well just acquire more shares or buy calls, treat it as a new position. It's like I said, I could have made money by selling the puts at the Thursday low, but then I'd have an unprotected position and that would run counter to the overall strategy.
In my case, I also sold a covered call when I bought the put, so the put was essentially free. Therefore, there really was no "decision" to make. It's a no-brainer, conservative trading strategy. Technically I could dispense with the long position entirely and just have an option spread, but I don't do collars every month, I just did this month because I saw the market as overvalued. In either case, the put is there to protect against sudden and unexpected downturns, like the one last week; it's expected to expire worthless, not be sold for a profit. If it's about to expire in the money, then you sell it and either roll over or sell the underlying stock.
So hopefully you see that there's not really much thinking involved with this. There are a lot of option strategies that do require a lot of thought and imply a high degree of risk; collars and protective puts aren't one of them. It's fire-and-forget, repeat once a month or once every few months if you expect low volatility.
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