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Friday, July 10, 2009

Alternate Short Strategy: Purchasing Put Protection for Less Part 3

As promised in my last two posts, Alternate Short Strategy: Purchasing Put Protection for Less, and Alternate Short Strategy: Purchasing Put Protection for Less Part 2 I will be continuing my list of alternate ways to hedge your portfolio without shorting the stock. To conclude my list, in this post (part 3) I will be covering the stocks ranked from 36 to 50 on the list of 50 (ranked from greatest to least by market cap).

To reiterate my two previous posts: I believe the market is due for a pull back, so it may be a good time to purchase put 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 Friday July 10, 2009.

Put Option Strategy #36: Buy the CVS (CVS) August 30 put and sell the August 29 put. This strategy would cost $28 per contract to open, and gives you protection starting at 30 down to 29. The current probability the options market is factoring in that the option will close at or below 29 by August 22 is 19.1%. 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 #37: Buy the Walt Disney (DIS) August 22 put and sell the August 21 put. This strategy would cost $35 per contract to open, and gives you protection of 4.5% starting at 22 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 29.7%.

Put Option Strategy #38: Buy the 3M (MMM) August 60 put (currently in the money) and sell the August 55 put. This strategy would cost $180 per contract to open, and gives you protection of 8% per share on this stock (downside of 4.79 points on current stock value of 59.79). The current probability the options market is factoring in that this spread will be filled is 22.6%.

Put Option Strategy #39: Buy the Gilead (GILD) August 44 put and sell the August 42.50 put. This strategy would cost $60 per contract to open, and gives you protection of 3.4% starting at 44 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 32.1%.

Put Option Strategy #40: Buy the Schering Plough (SGP) August 24 put and sell the August 22.50 put. This strategy would cost $42 per contract to open, and gives you protection of 6.25% starting at 24 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 23.1%.

Put Option Strategy #41:
Buy the Monsanto (MON) August 70 put and sell the August 65 put. This strategy would cost $172 per contract to open, and gives you protection of 7.1% starting at 65 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 23.3%.

Put Option Strategy #42:
Buy the Kraft (KFT) August 26 put and sell the August 25 put. This strategy would cost $40 per contract to open, and gives you protection of 3.9% starting at 26 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 32.2%.

Put Option Strategy #43:
Buy the Bristol-Myers (BMY) August 19 put and sell the August 18 put. This strategy would cost $51 per contract to open, and gives you protection of 5.3% starting at 19 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 24.6%.

Put Option Strategy #44: Buy the Home Depot (HD) August 22.50 put and sell the August 21 put. This strategy would cost $58 per contract to open, and gives you protection of 6.7% starting at 22.50 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 29.4%.

Put Option Strategy #45: Buy the Eli-Lilly (LLY) August 32.50 put and sell the August 30 put. This strategy would cost $78 per contract to open, and gives you protection of 7.7% starting at 32.50 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 20.6%.

Put Option Strategy #46: Buy the Comcast (CMCSA) August 13 put and sell the August 12 put. This strategy would cost $35 per contract to open, and gives you protection of 7.7% starting at 13 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 25.3%.

Put Option Strategy #47: Buy the Medtronic (MDT) August 32.50 put and sell the August 31 put. This strategy would cost $55 per contract to open, and gives you protection of 4.6% starting at 32.50 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 30.3%.

Put Option Strategy #48: Buy the Colgate-Palmolive (CL) August 70 put and sell the August 65 put. This strategy would cost $135 per contract to open, and gives you protection of 7.1% starting at 70 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 17.5%.

Put Option Strategy #49: Buy the Altria (MO) August 16 put and sell the August 15 put. This strategy would cost $22 per contract to open, and gives you protection of 6.25% starting at 16 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 15.3%.

Put Option Strategy #50: Buy the Amazon (AMZN) August 75 put and sell the August 70 put. This strategy would cost $166 per contract to open, and gives you protection of 6.7% starting at 75 per share on this stock. The current probability the options market is factoring in that this spread will be filled is 25.2%.

To reiterate my previous blog posts 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 ETF's such as BGZ, FAZ, SDS, and SKF, I am able to hedge as well. See more details here.

This post concludes the list of ideas which would help purchase put protection for cheaper on the list of the S&P 50.

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