Options Trading: The Protective Put Strategy In Different Scenarios
Topics: options trading, options trading strategies, stock options trading, stock trading
As previously stated, when we buy a stock, three potential outcomes exist. The stock can go up, go down, or remain stagnant. Let’s hypothesize results across these three scenarios. Say you buy the stock for $31.00 and buy the front month 30 put for $1.00.
In the ‘up’ scenario, let’s assume the stock price is $31.50 at expiration. The results are that you have a $.50 gain from capital appreciation and a $1.00 loss from the purchase of the put which combined gives us a $.50 overall loss.
It is important to realize that the up scenario will only produce a positive return if the stock gain is greater than the amount paid for the put. That being the case, you calculate the breakeven point for the protective put strategy by adding the purchase price of the stock to the price of the put.
In the ‘up’ scenario, add the stock price $31.00 plus the option price $1.00 and you get a breakeven of $32.00. So, until the stock reaches $32.00, the position will not produce a positive return. Above $32.00 the position will gain the amount equal to the stock price minus the premium paid for the option..
In the ’stagnant’ scenario, the position will produce a loss. Since the stock hasn’t moved, there will be no capital gain or loss and with the stock at $31.00 at expiration, the puts are worthless. The position lost $1.00, the amount you paid for the puts.
In the ‘down’ scenario, the position will again produce a loss. If the stock price were to trade down $1.00 to $30.00, then you would have a $1.00 capital loss.
With the stock at $30.00, the 30 puts will be worthless, thus you incur a $1.00 loss because that is what you paid for them. Your total loss will be $2.00.
However, in the ‘down’ scenario, the protective put will set a cap on your losses. Let’s see how that works. We’ll set the stock price down to $28.00. Since you purchased the stock at $31.00, there will be a capital loss of $3.00.
The puts, however, are now in the money with the stock below $30.00. With the stock at $28.00, the 30 puts are worth $2.00. You paid $1.00 for them so you have a $1.00 profit in the puts.
Combine the put profit ($1.00) with the capital loss (-$3.00) and you have an overall loss of $2.00. The $2.00 loss is the maximum amount you can lose regardless of how low the stock declines, even if it goes as low as zero. This is what is meant by maximum protection.
In every protective put position it is possible to calculate your anticipated maximum loss. Use the formula: (stock price minus strike price) minus the option’s price equals total maximum loss.
Maximum Loss = (Stock Price - Strike Price) - Option Price
For example, suppose you paid $30.00 for your stock. You bought the front month 27.5 put for $1.00. Next, assume the stock closes at $27.50 on expiration day.
Your maximum loss calculation would be:
($30.00 - $ 27.50) - $1.00 = $3.50
$30.00 (stock price) minus 27.5 (strike price) equals a $2.50 capital loss. Do not forget that with the stock at $27.50, the 27.5 puts will be worthless.
Add the capital loss ($2.50) plus the option loss ($1.00). The total is $3.50 which is your maximum possible loss in that position. This formula will work every time.
Looking at the three hypothesized scenarios, we find that only one scenario, the ‘up’ scenario, can produce a positive return and that’s only when the stock increases more than the amount you paid for the puts.
The other two scenarios produced losses. If the stock is stagnant, you lose the amount you paid for the put. If the stock goes down, you lose again- but the loss is limited. It is the limiting of loss that makes the protective put an attractive and useful strategy.
Ron Ianieri is currently Chief Options Strategist at The Options University, an educational company that teaches investors how to make consistent profits using options while limiting risk. For more information please contact The Options University at www.optionsuniversity.com or 866-561-8227
Previous Articles Highlighter:
Holiday Insurance - A Price You Cannot Afford To Save (1)
What Holiday Insurance All About Holiday insurance is also called vacation insurance. It will serve as a great backup plan for you if ever something untoward happens to you during your vacation travels.
What Are Credit-Based Auto Insurance Scores? (2)
Many companies use a value system whereby certain information is given a numeric value; those values are then added up and a resultant score is determined. In most cases, lower scores are more favorable than higher scores.
Student Loans Will Fund Your College Career (3)
Through these loans, everyone who might not have been able to go to school before, because of the lack of financial support, can now go! And if you remember to take note that student loans have interest rates that are lower than other loans available out there, the opportunity becomes much more attractive.
Your Health Insurance Plan - What You Need To Know (4)
But the benefits provided here are not that extensive. Another type of cover is personal health insurance, which is an option to ensure only yourself. Group health plans, on the other hand, are designed to ensure a group of people against unexpected health crisis.
Grants! Do I Qualify? (5)
There are companies that can help with this as they specialise in finding and winning you a grant on a no win/no fee basis that can make the process easier - but obviously you will sacrifice a percentage of the award if you do it this way.
Student Loans - Consolidation Can Change Your Life, Literally! (6)
As for the interest rates, here are some facts to take note of. Student loan consolidation rates are computed as the overall weighted average. This means that all the interest of the loans you are going to consolidate will be computed and the average of that will become the consolidation interest rate.
Your Dental Health Insurance Plans - What You Need To Know (7)
An individual type of dental scheme is naturally for each individual. This is fit for you if you have only yourself to worry about. But if you have a family, then it is best to take the dental health of your whole family into consideration as well.
Choosing A No Annual Fee Credit Card (8)
Picking the right card can be tricky and being aware of what type of agreement you are getting into is vital. Suggestions for Picking the Right No Annual Fee Credit Card Everything you need to know about a specific credit card and its policies can be found either on their website or in the fine print included with the card.
What's The Process For Fixing Mistakes On Your Credit Report? (9)
How do you fix an error that has wrongfully been made on your credit report? Who do you go to, what do you have to do yourself, how long will it take, and when, if at all, do I give up?
Do You Know What A Credit Reporting Agency Is? (10)
Whomever you are borrowing money from on credit, like a bank or a credit card company, probably "tells" on you periodically to the credit reporting agencies, so that they can determine your credit worthiness based on factors like how close you come to reaching your credit limit, how many late payments you have, and how much debt you are in at the present time.
First Steps To Understanding The Bankruptcy Code (11)
The bankruptcy was established and put into place to address those that are in financial trouble and for creditors to get their money back. This of course if a very general definition, but will serve the point.
Learning The Difference Between Legitimate Loans And Loan Schemes? (12)
How do you tell the difference between legitimate loans and scams? Here are a few things that will pose as a red flag as you search for a lender, letting you know the signs that who you are dealing with may just be in it for your money and who have no intention of lending you money whatsoever.
When Is An Installment Loan The Right Choice? (13)
This decreases your risk of going in the hole and not having enough money to pay your bills. Almost all installment loans do not ask you to provide collateral, mostly because what you bought with that loan can usually act as collateral itself.
Do You Even Know What You're Credit Score Is? (14)
When you get a credit card, buy a car using on a loan, or get a student loan, you need to consider how your actions will affect your credit score.
Your Credit Report - Seven Years Later (15)
Something that you many not consider to be very critical but that can affect you in more ways than you think is the fact that when you slip up even once with your credit card payments, it shows on your credit report for an entire seven years.
How Do You Know If Someone Has Used Your Credit To Obtain A Loan? (16)
Topics: federal student loans, stafford loans, credit cards Having your identity stolen is a big deal. Many people perhaps may not think so, but a lot of bad things can happen to you, just because someone knows enough about you to pretend to BE you.
If You're Upside Down In A Car Loan, How Can You Get Out Of It? (17)
This option will increase the amount of debt you have to pay off because of the high interest rates that are often attached to every loan that you apply to obtain.
What Do I Do If I Earn Too Much To Qualify For Student Loans? (18)
You can apply for scholarships through your school and also for private scholarships as well. Some scholarships require you to write an essay, some just want an application. You can search for these on-line, at the library, or through your financial aid adviser.
How Much Does A Kid Need To Save In Order To Be Ready For College? (19)
Save the money you make, and when the school year starts you will know where the monthly money goes with your previous made budget. Figure out where you will be getting money from each month, or in some cases every semester or quarter, and disburse it accordingly.
Retirees 'Need Finances In Shape Before Heading Abroad' (20)
Mark Dawson writes for the Loan Arrangers. Where visitors can compare cheap loans online, and apply for debt consolidation loans. To read more articles from Mark go to news.loan-arrangers.co.uk
Newer Articles Highlighter:
Investing In Energy Funds (1)
It depends upon how much risk you're willing to take and how your other assets are invested (think diversification of your entire portfolio). Having an energy investment might ease the pain the next time you fill up.
How To Asses Bankruptcy Petition Cost (2)
This way, you can also cut off the substantial amount in the attorney fee. However, you should note that it only reduces your filing bankruptcy cost; it does not cut off the role and importance of a good attorney.
Will My Credit History Affect My Student Loan Situation? (3)
One other main idea that people are not able to acquire a monetary loan is the unfortunate acquisition of bad credit throughout someone's lifetime. People can accumulate bad credit in a number of different ways, but mostly because they fail to pay their monthly loan payments, apply for multiple credit cards, do not pay off these credit cards, and simply do not pay companies back for all the money that they have borrowed.
Save Money On Groceries (4)
No matter how you choose to eat, there are ways to cut down on your grocery bills. A few more tips: --Menu plan --Make out a grocery list in advance, and stick to it!
Disputing Errors On Your Credit Report Can Save Your Score (5)
I mean after all, the credit reporting agencies are professionals who know what they're doing, so why should you have to worry about any mistakes? Actually, even professionals mess up sometimes, and in fact, the majority of people have found at least one error on their credit report before.
Tips On Refinancing Your Car Loan The Right Way (6)
The first includes simply paying off the loan without making a big ordeal out of it. If you want to pay off the loan even quicker, then you must find out a way that you can earn more money to pay with.
Can You Improve Your Credit Score By Paying Off Debts In Collections? (7)
Companies can be merciful to customers who put forth a lot of hard work and effort, and the results will be well worth it. Court helps people to learn about federal student loan consolidation.
How Do Borrowers With Bad Credit Get Car Loans? (8)
Subprime borrowers have many difficulties in obtaining various kinds of loan and must turn to other alternatives in order to make major purchases. Even though subprime borrowers often feel discouraged and see no way out of their situation, they must remember that there is always a solution to financial problems.
5 Great Reasons To Buy A Polaris World Property (9)
The nine golf courses that are spread over the seven resorts and will become an integral part of the Nicklaus Trail that will challenge golfers of all abilities from all over the world.
How Do You Know When You're Dealing With A Good Mortgage Lender? (10)
There is another fantastic spot where you can select an effective mortgage lender and that is by searching other local lenders and companies that offer mortgages. This process will require quite a bit of time and research, but in the end you will be able to compare and contrast the best and worst companies to work with.
Is It Wiser To Open A Home Equity Line Of Credit Or Get A Second Mortgage? (11)
Many home buyers realize that they should first acquire any kind of a mortgage to assist in the buying of a particular home. The process of obtaining a mortgage can be somewhat simple, depending on a person's credit score, and will be completed smoothly because of the assistance of an effective mortgage broker.
Don't Make These Common Auto Loan Mistakes (12)
You should always try to remember to use certain strategies and techniques that will most effectively help you to acquire an auto loan that fits your needs. Probably one of the most crucial aspects to maintain in remembrance when trying to obtain a car loan is to do all the research that it requires to obtain the most effective loan out there.
Advice On Getting Your Student Loan Interest Rate Reduced (13)
Many potential financial investors lack the knowledge of how to best complete an acquired loan, besides the general way of simply making large payments through the traditional monthly payment system.
If I Don't Pay My Doctor Bills, Will It Hurt My Credit Score? (14)
With this being the case, people must remember to pay them off as quickly as possible. Court helps people to learn about how to apply for credit cards. You can read more of his work by visiting: whalehookloans.com.
Is There Any Way To Improve Your Credit Without Actually Paying Off Your Judgments? (15)
Obtaining a high credit score helps you to more simply acquire credit cards and also get the loans that you will need to make major purchases. There are many customers, however, that neglect to maintain a high credit score and they must negatively encounter many monetary problems throughout their lives.
What's The Better Choice - Take A Bigger Loan Or Make A Bigger Down Payment? (16)
Even though there exist so many various types of monetary techniques and methods, there are some of these skills that work very well and bring about a lot of success for their users.
Want To Get A Mortgage? You Need To Improve Your Credit (17)
The financial world has become pretty brutal in the last several years, with fierce companies competing for your money in any way possible. In order to financially secure in today's society, you must abide by certain rules and strategies that will help guide you through the financial burdens that most people will have to eventually encounter in their lives.
A Simple Online Forex Trading Guide (18)
Online forex trading is a very friendly environment to amateur traders. Online foreign exchange brokers provide high end software solutions for all traders, including data, signal services, delivery options online, and trading applications that allow traders to match bids and offers.
Mortgage Refinancing Scams - Dangerous Waters (19)
This means that at the end of the loan period you will also have to give back the entire principle, referred to as a balloon payment. If you can not do this you will lose your home.
A Guide To Desiphering Forex Quotes (20)
This stability makes them safer investments than some other currencies. The feeling of security by investors results in the much higher trade volumes. To get more free articles and information on massage therapists please visit the following site : www.Fresh-Article-Directory.com
Permalink to Options Trading: The Protective Put Strategy In Different Scenarios