Using Options to Protect Gains While Maintaining Upside Potential

Posted On February 19, 2020 1:59 pm
By: Steve Smith

The stock market is hitting all-time highs and investors are torn between the possibility of an economic downturn or entering a new leg of the bull market.

Last week’s article noted that money managers were increasingly using call options to gain additional exposure to the stock market. Some of this behavior might be deemed as a reckless form of leveraging in an act of FOMO or fear of missing out as stocks shrug off every macro headwind virus to tariffs.

In the article, we touched on the use of a Stock Replacement, which is essentially replacing ownership of shares with the purchase of call options. This is a good time to review the process and benefits.

Replace Rather Than Remove

When people want to reduce risk but maintain upside exposure they usually think in terms of buying put protection as a form of portfolio insurance. While this can be effective in minimizing losses during a decline, it can have a significant drag on performance in the form of the cost of premium paid for put options.

An alternative approach is a… Continue reading at StockNews.com

Tagged with: options trading

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.