This is part one of two, in this article I'll take the bearish approach on the market, and give a Bear Put Spread option idea on each component of the Dow 30. In part two I'll take a bullish approach on the market with a Bull Call Option Spread idea on each.
To understand this post you'll need somewhat of a background in stock options. To learn more about options including this strategy, how options can help protect your portfolio, and allow you to speculate with less money up front click here.
Why use the Bear Put Spread Option Strategy instead of plain old put options?
The reason I like selling the spread when hedging my portfolio is because it allows me to hedge for a cheaper premium, and although it gives me less downside protection, I believe it should protect the majority of the move lower if the market does correct in the month to come.
All data as of market close Tuesday July 21, 2009.
HOW TO READ THE TABLE
- Price - This is the closing price [last quote price at market close] of the security
- High - This is the higher strike price of the two Put option contracts, the one being purchased in my examples. To keep things simple I chose the option strike price closest to the closing price. Some strikes may be below current share price and some may be above.
- Low - This is the lower strike price of the two put option contracts, the one being sold in my examples. I took the strike at least 5% lower from the current share price.
- % Missed - This is how much the given stock will fall by before the higher of the two put options starts protecting your position. Stocks currently below the higher strike price do not have any % miss, as they are in the money.
- % Protect - This is how much protection the option spread protects your position. The difference between the high strike and the low strike, or current share price to low strike (for in the money examples).
Buy the 3M (MMM) August 65 put and sell the August 60 put. This position gives you protection of up to 6.54% [$4.20 per share] on 3M (hedges position down to 60 a share until August 22, 2009). This position is currently in the money by 80 cents ($0.80) a share which means % missed does not apply. This spread strategy would cost $190 per contract to open, versus $265 for each August 65 strike put option contract purchased.
|Company||Ticker||Price||High||Low||% Missed||% Protect|
|Cisco Systems Inc||CSCO||21.59||22||20||0.00||7.36|
|International Business Machines||IBM||117.04||120||110||0.00||6.02|
|Johnson & Johnson||JNJ||59.49||60||55||0.00||7.55|
|JP Morgan & Chase & Co||JPM||36.94||37||35||0.00||5.25|
|Kraft Foods Inc.||KFT||27.58||28||26||0.00||5.73|
|Merck & Co., Inc.||MRK||29.65||30||27||0.00||8.94|
|United Technologies Corporation||UTX||53.97||55||50||0.00||7.36|
|Wal-Mart Stores, Inc.||WMT||48.86||50||45||0.00||7.90|
|American Express Company||AXP||29.38||29||27||1.29||6.90|
|Bank of America Corporation||BAC||12.19||12||11||1.56||8.33|
|E.I. du Pont de Nemours and Company||DD||28.32||28||26||1.13||7.14|
|Exxon Mobil Corp||XOM||70.47||70||65||0.67||7.14|
|General Electric Company||GE||11.47||11||10||4.10||9.09|
|The Coca-Cola Company||KO||50.35||50||47.5||0.70||5.00|
|The Home Depot, Inc.||HD||24.46||24||22.5||1.88||6.25|
|The Procter & Gamble Company||PG||55.49||55||50||0.88||9.09|
|Travelers Companies Inc||TRV||40.71||40||35||1.74||12.50|
|Walt Disney Company||DIS||25.2||25||23||0.79||8.00|
These options expire on August 22, 2009; therefore the last trading day is Friday August 21, 2009.
These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly. To learn more about the option spread strategy and other option strategies check out my option trading books.
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. One reason option volumes have exploded over the past 5 years is because they are a great way to hedge your portfolio (see chart here).
Below is a picture of the spreadsheet I used to calculate these values (click on the image to enlarge).
Sphere: Related Content