Put Question
- Thread starter bulletbob
- Start date
IMHO: {this is NOT my interest area, so take with grain of salt} A logical question. But like shoe sizes, one size fits few or none! May be wise to consider "bottom-up" analysis prior to "top-down" analysis. That way you know if the top-down works for your specific case. -- Examine the best practices for the specific underlying's you plan to trade. -- IE... For your specific case, the cost of PUT protection may be waste of money!
OTM Puts.
Similar constructs in a CashAcct are CashSecuredPut and CashSecuredPut + LongPut.
These 2 constructs do use Cash instead of the LongStock.
A better construct is available in MarginAcct:
- CallSpread consisting of ShortCall + LongCall
- PutSpread consisting of ShortPut + LongPut,
These do require much less margin/cash.
They all are similar if the strike of the LongLeg is less then the strike of the ShortLeg; ie. bullish, meaning a rising underlying is beneficial, and v.v.
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Here is an example strategy where they use a protective put 15-20% OTM:
https://www.thebluecollarinvestor.com/covered-call-writing-with-protective-puts-a-proposed-strategy/
https://www.thebluecollarinvestor.com/covered-call-writing-with-protective-puts-a-proposed-strategy/
When you do a covered call and a protective put, that is commonly referred to as a collar.
I was going to point you to the optionsplaybook website for information about how collars work, but it looks like either the site is down, or Ally Financial has taken it offline.
The optionsplaybook was a really good website with a concise description of about 40 different options strategies. If Ally took it offline, or somehow fouled up their relationship with the author, Brian Overby, then that was a really dumb move.
The book is still available on Amazon.
I was going to point you to the optionsplaybook website for information about how collars work, but it looks like either the site is down, or Ally Financial has taken it offline.
The optionsplaybook was a really good website with a concise description of about 40 different options strategies. If Ally took it offline, or somehow fouled up their relationship with the author, Brian Overby, then that was a really dumb move.
The book is still available on Amazon.
So synthetically you are trading bull put spreads. Your position is bullish so buy the long put where your view is proved wrong and you would stop out at that point.
Synthetically you are trading a call vertical. Stock + put is a call .... and then the short call creates a call vertical. The strike of the put should be thought of as the insurance deductible. Cheaper to do the vertical, unless you already own the stock. You gain alpha if you play the erosion curve. Sell the short call short dated and buy the embedded long put or the long option in the synthetic longer dated. The nice thing about this trade is could eventually end up owning the vertical below parity. Your selling the shortest part of the erosion curve and buying slower erosion if you use your 6 month option. Very popular in the liquid ETFs. Selling short dated calls raises the likelihood of being called away, but in a zero commission environment you can just replace the lost underlying part of the synthetic and it also provides an opportunity to adjust up - should you chose to do so.
When trading covered calls and seeking downside protection, the choice of puts depends on your specific risk tolerance and objectives. Let's discuss the three options you mentioned: slightly out-of-the-money (OTM) puts, slightly in-the-money (ITM) puts, and at-the-money (ATM) puts.
1. Slightly OTM Puts:
Pros:
- Lower Cost: OTM puts tend to have a lower premium compared to ITM or ATM puts. This means that you can potentially hedge your downside risk at a lower cost.
- Potential for Capital Gains: If the stock price remains above the strike price of the OTM puts, the puts may expire worthless, allowing you to keep the premium collected from selling the covered call while maintaining downside protection.
Cons:
- Less Immediate Protection: OTM puts provide less immediate protection compared to ITM or ATM puts. If the stock price drops significantly, the value of the OTM puts may not increase enough to fully offset the losses on the stock.
2. Slightly ITM Puts:
Pros:
- More Immediate Protection: ITM puts provide more immediate downside protection compared to OTM puts. If the stock price declines, the intrinsic value of the ITM puts increases, helping offset some of the losses on the stock.
Cons:
- Higher Cost: ITM puts tend to have a higher premium compared to OTM puts, as they already have intrinsic value. This means you will need to pay a higher premium for the protection they provide.
3. ATM Puts:
Pros:
- Balanced Protection: ATM puts offer a balance between immediate protection and cost. They have both intrinsic and extrinsic value, providing some downside protection while not being as expensive as deep ITM puts.
Cons:
- Moderate Cost: ATM puts typically have a moderate premium, which means you will incur a moderate cost for the downside protection they offer.
Ultimately, the choice of puts depends on your risk tolerance and the level of downside protection you desire. Slightly OTM puts may be suitable if you are comfortable with a lower level of immediate protection and want to minimize costs. Slightly ITM puts can offer more immediate protection but come at a higher cost. ATM puts provide a balance between the two, offering a moderate level of protection at a moderate cost.
1. Slightly OTM Puts:
Pros:
- Lower Cost: OTM puts tend to have a lower premium compared to ITM or ATM puts. This means that you can potentially hedge your downside risk at a lower cost.
- Potential for Capital Gains: If the stock price remains above the strike price of the OTM puts, the puts may expire worthless, allowing you to keep the premium collected from selling the covered call while maintaining downside protection.
Cons:
- Less Immediate Protection: OTM puts provide less immediate protection compared to ITM or ATM puts. If the stock price drops significantly, the value of the OTM puts may not increase enough to fully offset the losses on the stock.
2. Slightly ITM Puts:
Pros:
- More Immediate Protection: ITM puts provide more immediate downside protection compared to OTM puts. If the stock price declines, the intrinsic value of the ITM puts increases, helping offset some of the losses on the stock.
Cons:
- Higher Cost: ITM puts tend to have a higher premium compared to OTM puts, as they already have intrinsic value. This means you will need to pay a higher premium for the protection they provide.
3. ATM Puts:
Pros:
- Balanced Protection: ATM puts offer a balance between immediate protection and cost. They have both intrinsic and extrinsic value, providing some downside protection while not being as expensive as deep ITM puts.
Cons:
- Moderate Cost: ATM puts typically have a moderate premium, which means you will incur a moderate cost for the downside protection they offer.
Ultimately, the choice of puts depends on your risk tolerance and the level of downside protection you desire. Slightly OTM puts may be suitable if you are comfortable with a lower level of immediate protection and want to minimize costs. Slightly ITM puts can offer more immediate protection but come at a higher cost. ATM puts provide a balance between the two, offering a moderate level of protection at a moderate cost.
Just a clarification:
The net credit (= premium of ShortCall minus premium of LongPut) received will be kept in full only if the stock price at expiration is >= strike of the ShortCall.
If the stock price is below the strike of the ShortCall and above the B/E point then only part of the net credit will be kept.
If the stock price is below the B/E point then loss starts and grows up to MaxLoss at the strike of the LongPut, but below that the loss gets capped.
Best studied visually in PnL diagram --> https://optioncreator.com/stypjvp
In the example:
LS: S=100
SC: K=100 DTE=90 IV=70 --> Pr=13.7975
LP: K=90 DTE=90 IV=70 --> Pr=8.6985
-->
CostBasis = LS - SC.Pr + LP.Pr = 100 - 13.7975 + 8.6985 = 94.9010
MaxWin=SC.Pr-LP.Pr=NetCredit=5.0990 (= 5.37%)
MaxLoss=SC.K-LP.K-MaxWin=4.9010 (= -5,16%)
BE @ Sx=94.9010 (= LP.K + MaxLoss)
These formulas for this Collar are valid only for a bullish construct, ie. if LP.K <= SC.K.
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