(Don’t) Feel the Pain

• Posted by Adam Warner
• on November 3rd, 2009

So you rode The Rally of 2009 and want to lock something in, yet still keep those upside shots, but at the same time don’t want to pay those sky high options premiums. How do you accomplish all that? (The One and Only) Steven Sears has some ideas in The Striking Price.

Michael Schwartz, the dean of the options strategists, likes using a “bear spread” to protect stocks, and preserve gains.

This entails buying the Standard & Poor’s December 1000 put, and selling the December 970 put, which lowers the cost of hedging. When options volatility is elevated, or even a concern, many investors “spread off” the extra expense by selling an option even as they buy one.

The position cost $8, when Schwartz, Oppenheimer’s chief options strategist modeled the trade.

Schwartz advised clients of this trade as a precaution against the stock market “filling gaps” — which occurs when stocks, or stock indexes open at points that are lower or higher than their closing price.

Since March, five “gaps” have punctured the Standard & Poor’s 500 Index. Last week, the gap of 1075.30/1078.68 and 1058.02 to 1060.03 were filled during the decline.

It does indeed keep you from getting bagged owning pumped volatility. The drawback of course is that it only protects you down to the lower strike, although a better way to look at it is you’ll pocket $22 per SPX contract if the spread maxes out, so you can obviously protect more if you do more spreads.

I guess I like the concept though in that I did some similar trades as protection. I bought some -2x Inverse SPX (SDS) call verticals and sold 3x Russell (TNA) call verticals as hedges and in hindsight….well, should have done many more TNA’s, lol. So I’d say by personal experience it really is all about the sizing

 

 

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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