Protective puts v which is better

Post on: 16 Июнь, 2015 No Comment

Protective puts v which is better

TK All-Star posted on 02/13/09 at 01:22 PM

Doc Maher weighs these two hedging strategies.

Stugots caught my eye recently with a protective put on AAPL. It’s an interesting trade because this play is “synthetic” for another options play, the long call. It’s a topic I’ve been meaning to dig into for a while. I’ve commented on Stugots’ trades in the past, so I hope he’s as gracious about it as before.

On 2/4/09 Stugots bought shares of AAPL and then bought a Feb 95 put for $3.00 to hedge the position. At first he only bought 80 shares of AAPL at $95.95. I’m not sure why because the put “covers” 100 shares. (Later he bought another 20 shares to make it an even 100.)

First let’s look at AAPL’s chart.

The P+L graph for buying 100 shares at $95.95 is below. This is probably familiar to everyone. If the stock goes up $1 you make $100. If it goes down $1 you lose $100, less commissions of $14.85 for the stock trades — very straightforward. (Check out TradeKing’s P+L Calculator under Tools.)

But now look what happens when you add a $95 strike put for $3.00.

This did exactly what we wanted: limited the downside. If AAPL goes below $95, we have the right to sell it at $95. So our maximum loss in this case is $0.95 per share and the $3.00 we spent for the put or $3.95, $395 total for the 100 shares. The upside is still unlimited; however, it’s reduced by the $3.00 per share we spent on the put. (Commissions to enter and exit this stock and put position come to $26.05. Be sure to include this in your profit or loss projections.)

Does the P+L shown above remind you of anything? If you said it looks like a long call’s P+L, you’re absolutely right. At the time stugots bought the Feb 95 put for $3.00, the Feb 95 call was going for $3.90. Shown below is the P+L for a long Feb 95 call.

So buying the stock with a protective put is the same as buying a long call – that is, long stock plus long put create a “synthetic” long call.

So what’s the difference between these strategies?

Well, the max loss and potential profit are about the same. However, for the long stock + put we invested $9,595 + $300 = $9,895. For the long call we invested $390.

As you can see, the call produced a much greater potential percentage profit due to the lower investment. In fact the Feb $95 call went as high as $8.85 on 2/9. That’s more than a double. If follow my blogs, you know I always have an exit plan that would have likely captured a big part of that move. (For the long call trade, you need to include commissions of $11.20 to cover the entry and exit.)

What else is different? When the call expires, you have nothing. Stock never expires, so when the put expires you’re left with the stock. Of course it would be unprotected and possibly you would be temped to buy another put. In stugots’ case the trade was ended on 2/11 so it didn’t come to that.

Protective puts versus plain old stop orders

Protective puts v which is better

Stugots did nothing wrong with this trade, but I’ll be honest: I’ve never been a fan of protective puts. I hope the above discussion shows why.

If I want the P+L of a long call, I’ll buy a long call. It’s cheaper. If I owned stock, the only time I’d use a protective put is if there were some reason I couldn’t sell it. Otherwise a stop order seems to protect my downside pretty well and, unlike buying a put, it doesn’t cost anything.

Dig into further reading

My colleague Brian Overby, the Options Guy, did a great blog series, Put Options Explained. I’m not sure if he shares my opinion about protective puts, but I am sure this is a great, informative read on puts generally.

To learn more about managing your trade exits with stops, check out my post on that. TradeKing’s own Neal Atkins explains how trailing stop orders work in this forum thread. Last but never least, Brian Overby explains the difference between stop and contingent orders – and why you should consider using either.

Feel free to comment with your questions or email me at Docmaher@docmahertrading.com – I’m happy to hear from you!

—Doc Maher

Income Trader

All-Star Commentator

Doc’s previous posts: Hitting a snag with Ford LEAPS and The trade that got away: Ford LEAPS

Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.


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