The nearly 1000 point intraday sell off in the DJIA has many stock investors looking for ways to protect their portfolios. In addition, the spiking Volatility Index (VIX) triggered option traders to seek ways to profit from the large price swings expected to continue. This blog post will discuss two options strategies working now. One is designed to protect your gains, and the other is built to profit from the chaotic action regardless of direction.
Most stock investors are sitting on nice profits due to the market’s massive gains since the 2008 bottom. A simple option strategy offers a way to protect these gains, while still remaining exposed to possible limited upside. This strategy is known as a Collar. It entails purchasing a protective put and writing a call on the stock you already hold. It’s buying one put and selling one call at the same strike price per 100 shares of owned stock. The idea is that the premium received for the call sale will offset or even cover the price of the put completely. Often a net credit is available when instituting this strategy. The call sale limits the upside while the put purchase protects the downside. In plain language, this tactic “collars” your losses in exchange for limiting the upside exposure. Assuming the trader already has a profit in the underlying stock when the protective put is purchased and the call is sold, there is no maximum loss. However, one can lose the entire net premium paid for the Collar or keep the net cash credit if the underlyers price remains between the strike prices when the options expire.
The next strategy for these volatile times is called a Long Straddle. This tactic profits from the movement of the underlying stock regardless of direction. The method is employed when the trader is expecting a large move in the underlying but is unsure of the direction. It is the simultaneous purchase of a call and a put at the same strike price. In other words, the strike price is “straddled” on the down side and upside. Profits are realized once the premium is covered on both legs of the trade. The maximum loss with this tactic is limited and predetermined. It is equal to the premium paid for both legs of the trade. It occurs when the underlying stock price matches the strike price of the options at expiration.
Regardless of the strategy, traders must keep in mind that options contain inherent risk. For a deeper look at the risk involved, visit the Option Industry Council.
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