By: Steve Smith
With the recent rebound in stocks, the “SPDR Trust (SPY)” has now regained more than half its losses and is just 11% from all-time highs. It makes sense to look at some hedging or portfolio protection strategies.
How Much Protection & For How Long?
Buying put options does offer the most complete and probably efficient way to hedge a position, but it comes at a cost. And that cost, as with all insurance policies, will be a function of the amount of protection and its duration. The main items to consider when choosing put protection — whether for an individual stock or a broad equity portfolio — are:
1. What magnitude of a decline is expected?
2. At what level of the decline do you want the position to be fully hedged or protected?
3. For what length of time do you want the protection in place?
Answering these questions will help you determine the appropriate number of puts to buy at a given strike with a certain expiration date. By using the basic applications of the delta, in which an at-the-money option is expected to move 0.50 for every $1 unit price move in the underlying security, one can begin to assess how much and at what levels and cost protection can be purchased.
Let’s you have a $100,000 portfolio that is benchmarked to the S&P 500 Index or a position equivalent to owning 480 shares of the SPY. You want to establish protection to carry you through the first few months of the year, which will include Q1 earnings report that could set the tone of the trend for the year, I’d suggest using a combination of spreads.
For example, the 3-step approach, using SPY options to create portfolio protection:
1. Use a… Continue reading at StockNews.com