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Thursday, July 9, 2009

Alternate Short Strategy: Purchasing Put Protection for Less Part 2

As promised in Alternate Short Strategy: Purchasing Put Protection for Less, I will be continuing my list of alternate ways to hedge your portfolio without shorting the stock. In this post (part 2) I will be covering the stocks from 21 to 35 on the list of 50 (ranked by market cap). To reiterate my previous post: I believe the market is due for a pull back, so it may be a good time to purchase protection on some of your long positions. I decided to write about the 50 largest stocks (by market cap) in the S&P 500 and give a put protection strategy for each of them. To get a detailed spreadsheet of all 500 stocks, which will allow you to rank them based on their market cap minute by minute with the click of a mouse check out my blog post here.

If you're coming across this post you most likely hold or at least have interest in a stock I'll be talking about shortly. In this article I will lay out 15 option ideas, which will help hedge your portfolio against the downside. These ideas all require using the Bear Put Option Spread Strategy.

Therefore this post requires the knowledge of stock options, as I'll be talking about opening up a Bear Put Spread option position on each of the stocks listed. If you need help understanding options, or to learn more about opening up one of these positions (and options in general) click here.

The puts purchased/sold in this post are for the August option expiration. The put being purchased is the strike price lower and closest to the current share price, and the put being sold is the next highest put available (below the put being purchased).

All data as of market close Thursday July 9, 2009.

Put Option Strategy #21: Buy the Philip Morris International (PM) August 42 put and sell the August 41 put. This strategy would cost $44 per contract to open, and gives you protection starting at 42 down to 41. The current probability the options market is factoring in that the option will close at or below 41 by August 22 is 35.3%. With 1 point strike increments on higher priced stocks, it may be worth to look into selling an even lower put. You'll have more at risk but you'll also have more protection.

Put Option Strategy #22: Buy the Verizon (VZ) August 28 put and sell the August 27 put. This strategy would cost $32 per contract to open, and gives you protection of 3.6% starting at 28 per share on this stock. The current probability the options market is factoring in that this spread will be filled (meaning the stock closes at or below the lower strike price at expiration) is 27.7%.

Put Option Strategy #23: Buy the Bank of America (BAC) August 12 put (currently in the money) and sell the August 11 put. This strategy would cost $45 per contract to open, and gives you protection of 8.1% per share on this stock (downside of 97 cents on current stock value of 11.97). The current probability the options market is factoring in that this spread will be filled is 32.7%.

Put Option Strategy #24: Buy the Goldman Sachs (GS) August 140 put and sell the August 135 put. This strategy would cost $198 per contract to open, and gives you protection of 3.6% starting at 140 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 33.9%. Note that on these higher priced, more volatile stocks it may be worth selling an even lower strike than the one indicated (such as the 130 or even 125).

Put Option Strategy #25:
Buy the Qualcomm (QCOM) August 43 put and sell the August 42 put. This strategy would cost $43 per contract to open, and gives you protection of 2.3% starting at 43 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 47.2%.

Put Option Strategy #26:
Buy the Abbott Labs (ABT) August 45 put and sell the August 44 put. This strategy would cost $37 per contract to open, and gives you protection of 2.2% starting at 45 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 33.2%.

Put Option Strategy #27: Buy the McDonald's (MCD) August 57.50 (currently in the money) put and sell the August 55 put. This strategy would cost $111 per contract to open, and gives you protection of 3.1% starting at 56.77 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 35%.

Put Option Strategy #28: Buy the Schlumberger (SLB) August 50 put and sell the August 45 put. This strategy would cost $190 per contract to open, and gives you protection of 10% starting at 50 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 25.1%.

Put Option Strategy #29: Buy the Wyeth (WYE) August 45 put (currently in the money) and sell the August 40 put. This strategy would cost $88 per contract to open, and gives you protection of 5.3% starting at 44.89 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 26.7%.

Put Option Strategy #30: Buy the ConocoPhillips (COP) August 40 put and sell the August 39 put. This strategy would cost $46 per contract to open, and gives you protection of 2.5% starting at 40 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 39%.

Put Option Strategy #31: Buy the Amgen (AMGN) August 57.50 put and sell the August 55 put. This strategy would cost $93 per contract to open, and gives you protection of 4.3% starting at 57.50 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 31%.

Put Option Strategy #32: Buy the Merck (MRK) August 27 put and sell the August 26 put. This strategy would cost $43 per contract to open, and gives you protection of 3.7% starting at 27 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 37.7%.

Put Option Strategy #33: Buy the Occidental Petroleum (OXY) August 60 put and sell the August 55 put. This strategy would cost $165 per contract to open, and gives you protection of 8.3% starting at 60 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 24.2%.

Put Option Strategy #34: Buy the UPS (UPS) August 50 put (currently in the money) and sell the August 45 put. This strategy would cost $240 per contract to open (already $198 in the money), and gives you protection of 6.3% starting at 48.02 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 30.9%.

Put Option Strategy #35: Buy the United Technologies (UTX) August 50 put (currently in the money) and sell the August 45 put. This strategy would cost $180 per contract to open, and gives you protection of 9.4% starting at 49.65 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 22%.

To reiterate my previous blog post again: A general rule I like to follow is to sell the put contract about 7%-15% lower than the strike price of the put contract I purchased. The reason I like selling the spread when hedging my portfolio is because it allows me to hedge cheaper, and although it limits my downside protection, I believe it should protect the majority of the move lower.

These options expire on August 22, 2009, therefore the last trading day is Friday August 21, 2009. As you can see on average the greater the protection the more expensive the contract is to open.

If you're more bullish/bearish you’ll want to adjust the strike price accordingly. If you’re even more bearish, sell a put much lower than the one purchased, or don't sell a put at all. The cost will be more expensive to open the contract, however the downside protection will be greater.

This strategy is a great way to hedge your portfolio. The reason option volumes have exploded over the past 5 years is because they are a great way to hedge your portfolio (see chart here).

If you want to protect your overall portfolio, you may find another strategy I've been using more useful. By using option strategies on the double and triple short leveraged ETFs such as BGZ, FAZ, SDS, and SKF, I am able to hedge as well. See more details here.

Part 3 will be ready after market close Friday July 10, 2009.

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