Market Crash + Puts = ?

MTE: thank you so much for taking your time to reply
and whats more: its so clear!

what would now happen if I dont buy them outright, but could I place a stop buy order so that my money is not tied up?

So I think along the lines of:
only on the day that the SPX falls heavily, would I really want to invest in protection.
when the SPX falls to 1410 my stop buy order gets triggered and becomes a market order.
your delta is 0.34 so the price will be around 68.50 for a March 2008 SPX 1450 put?
so I buy those puts on that day at 68.50 for further protection.
I might buy 1 put more to cancel the loss my portfolio suffers from the SPX going down from 1450 to 1410 before buying the protection.
Is it possible to place a stop buy order for a put and is this scenario feasible?
What percentage of the value of the stop buy order should be in the broker account before being able to place the stop buy order?

hope I`m not asking too much.

thanks:cool:
 
Quote from MTE:

If your portfolio is fairly diversified then you could buy Mar 08 1450 puts for about 55.00. Let's suppose that the beta of your portfolio with respect to SPX is 1.2. So the adjusted value is $500,000*1.2=$600,000. The value of 1 SPX contract is 1450*100=145,000. So, 600,000/145,000=4.14 or 4 contracts. Therefore, in order to hedge your portfolio you would buy 4 SPX Mar 08 1450 puts at 55.00. The cost is 22,000 (55*100*4), which is 4.4% of your portfolio.

If the beta of your portfolio is 1 then you'd need 3.44 contracts, but since you can only buy whole contracts you'd have to round it down to 3 or you could add some XSP puts (XSP is the mini-SPX, i.e. 1/10th the size of the SPX) to fine tune the number of contracts. So, you could buy 3 SPX and 4 XSP puts. The cost would be 18.700 or 3.74% (3*55*100=16,500 plus 4*100*5.5=2,200).

One note of caution, the above mentioned put is ATM so, it will provide a FULL hedge ONLY AT EXPIRY in Mar 2008, you will be hedged from current level though as the put strike is 1450, which is where the SPX is, so for every point that the SPX is below 1450 in Mar 2008 you get 1 point. If you were to buy those puts and the market sells off next week then you won't be fully hedged as the current delta of the put is only 0.34 so for every 1 point move in the SPX the put moves 0.34. Obviously, as the put moves further ITM and closer to expiration the delta and thus the hedging effect increases.

EDIT: In other words, if the market sells off 100 points next week and you decide to cash in the hedge, you'll get only about 45 points in profit on those puts.

If the market is 100 points down next March then you'll get the full 100 points in profit.
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Hi MTE
I'm a little bit baffled here.
I thought the FULL hedge exists from the moment you open the position and reaches its max loss potential at expiry, i.e. the cost of the put puchase. So if the market sold off next week your loss would be less than if it sold off to the same level on the day of expiry (since there would still be some extrinsic value in the long puts). Iow one would be better off to close the whole position early if there's a market downturn next week than to wait til expiry and take maximum loss. In your example with the 100 point drop in SPX next week, the hedge would lose less than with the same drop in SPX at expiry. So how can you say that it isn't fully hedged til expiry?
I see the hedge as simply behaving like a long call where the max loss is the call premium paid. Am I missing something?
Cheers
db
 
Quote from MTE:

EDIT: In other words, if the market sells off 100 points next week and you decide to cash in the hedge, you'll get only about 45 points in profit on those puts.

If the market is 100 points down next March then you'll get the full 100 points in profit.
More...
Very good example and explanation of portfolio hedging. But I'm a bit confused by this statement and I'm not sure how to express it.

In terms of delta, at Mar '08 expiration, the delta will be 1.00 and there will be a 1:1 recovery for drop. But at that point in time, there will also be 55 pts of decay plus the small amount of non-protection down to strike. OTOH, if the drop occurs next week, there's little time decay and therefore, despite the lower delta, the net loss is less.

IOW, the sooner the drop, the less the loss. N'est ce pas?
 
If I recall correctly, I actually had a put or two on Expedia just prior to 9/11. Those puts quadrupled within a couple of days after the markets opened again. The third quarter of 2001 was my best quarter in terms of performance ever, but it probably was a curse too because I think I felt somewhat guilty about the fact that I profited as the result of what happened. For the record, I was having a good quarter prior to 9/11 but the event really created even more of a windfall. I felt guilty about it for a while and it adversely affected my trading for a long time.



Quote from tj1320:

I have a question about market crashes and how it affects options. My mother brought this up to me because she is worried that I'll lose my money if the market crashed like it did in '29 and '87. I told her that if I had puts that I would profit greatly from a market crash and she doesn't believe me. I don't understand her way of thinking but is there any reason puts wouldn't be highly profitable if the market crashed again?

I had calls prior to 9/11 otherwise I would have profited handsomely, based on the price movements I saw in the puts. I can't remember which stock it was now but I had some calls I purchased at around $4, give or take, and they went to around $.50 in the blink of an eye. I noticed that the puts had doubled, tripled, and even quadrupled VERY quickly. That said, how can a crash be bad for bearish positions?
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Quote from daddy'sboy:

Hi MTE
I'm a little bit baffled here.
I thought the FULL hedge exists from the moment you open the position and reaches its max loss potential at expiry, i.e. the cost of the put puchase. So if the market sold off next week your loss would be less than if it sold off to the same level on the day of expiry (since there would still be some extrinsic value in the long puts). Iow one would be better off to close the whole position early if there's a market downturn next week than to wait til expiry and take maximum loss. In your example with the 100 point drop in SPX next week, the hedge would lose less than with the same drop in SPX at expiry. So how can you say that it isn't fully hedged til expiry?
I see the hedge as simply behaving like a long call where the max loss is the call premium paid. Am I missing something?
Cheers
db
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Quote from spindr0:

Very good example and explanation of portfolio hedging. But I'm a bit confused by this statement and I'm not sure how to express it.

In terms of delta, at Mar '08 expiration, the delta will be 1.00 and there will be a 1:1 recovery for drop. But at that point in time, there will also be 55 pts of decay plus the small amount of non-protection down to strike. OTOH, if the drop occurs next week, there's little time decay and therefore, despite the lower delta, the net loss is less.

IOW, the sooner the drop, the less the loss. N'est ce pas?
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Well, yes, the cost of the put would offset some of that profit, sorry I forgot to mention that, but the point is that you don't get 1:1 cover for the drop if the drop happens next week, cause for a full hedge you need to be delta-neutral.
 
Quote from MTE:

Well, yes, the cost of the put would offset some of that profit, sorry I forgot to mention that, but the point is that you don't get 1:1 cover for the drop if the drop happens next week, cause for a full hedge you need to be delta-neutral.
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But you do get the full cover (even prior to expiry), that's what I and spindro are on about. You are hedging long stock with a long put, giving you a SYNTHETIC LONG CALL. The max risk is then the premium paid for the long call, no matter when/if it tanks. Iow a full hedge from the word go.
Cheers
db
 
Quote from daddy'sboy:

But you do get the full cover (even prior to expiry), that's what I and spindro are on about. You are hedging long stock with a long put, giving you a SYNTHETIC LONG CALL. The max risk is then the premium paid for the long call, no matter when/if it tanks. Iow a full hedge from the word go.
Cheers
db
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Yes, the premium paid is the max risk. As I said, you are correct, my wording wasn't the best I guess as I meant to mention delta-hedging compared to normal put hedging.

Anyway, sorry for the confusion. (I guess the age is catching up with me):D
 
Quote from daddy'sboy:

But you do get the full cover (even prior to expiry), that's what I and spindro are on about. You are hedging long stock with a long put, giving you a SYNTHETIC LONG CALL. The max risk is then the premium paid for the long call, no matter when/if it tanks. Iow a full hedge from the word go.
More...
OK, I think that I got it now. I'm going to take the middle ground and let you and MTE lob 'em over my head at each other (wink).

Seriously, I think that it's a question of what you call a full hedge (semantics?). My take is that fully hedged means that as MTE said, delta neutral. In the case of a protective put on its own underlying, the put(s) is a hedge but not quite a full hedge since there's the potential loss of the premium plus distance to strike if OTM (aka the synthetic call premium).

OK, I'm ducking (out) now :)
 
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