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January 23, 2014

Thoughts on Front-Month Puts

With the market threatening to move lower after a bullish run last year and earning’s season upon us,it might be a good time to talk about put options. If a trader buys a put option, he or she has the right to sell the underlying at a particular price (strike price) before a certain time (expiration). If a trader owns 100 shares of stock and purchases a put option, the trader may be able to protect the position fully or to some degree because he or she will have the right to sell the stock at the strike price by expiration even if the shares lose value.

A lot of traders especially those who are just learning to trade options can be smitten by put options especially buying the shortest-term, or front month put for protection. The problem, however, is that there is a flaw to the reasoning of purchasing front-month puts as protection. Front-month contracts have a higher theta (time decay) and relying on front-month puts to protect a straight stock purchase is not necessarily the best way to protect the stock. If you were to continually purchase front-month puts as protection, that can end up being a rather expensive way to by insurance.

Although front month options are often cheaper, they are not always your best bet. The idea may be sound, the trader purchases a number of shares of the stock and purchases out-of-the-money puts to protect his or her position; but sound reasoning does not always lead to good practice. Here’s an example.

We will use a hypothetical trade. The stock is trading a slightly above 13 and our hypothetical trader wants to own the stock because he or she thinks the stock will beat its earnings’ estimates in each of the next two quarters. This investment will take at least six months as the trader wants to allow the news events to move the stock higher.

Being a smart options trader, our stock trader wants some insurance against a potential drop in the stock just in case. The trader decides to buy a slightly out-of-the-money July 13 put, which carries an ask price of $0.50 (rounded for simplicity purposes). That 0.50 premium represents almost 4 percent of the current stock price. In fact, if the investor rolled option month after month, it would create a big dent in the initial outlay of cash. To be sure, after about seven months (assuming the stock hangs around $13) the trader would lose more than 25 percent on the $13 investment.

If the stock drops in price, then the ultimate rationalization for the strategy is realized; protection. The put provides a hedge. The value of the option will increase as the stock drops, which can offset the loss suffered as the stock drops. Buying the put is a hedge and and a solid insurance policy – though, albeit, an expensive one. Investors can usually find better ways to protect a stock.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

April 18, 2013

Front-Month Puts May Not be the Best Solution

With the market threatening to move lower after a bullish run to start the year and earning’s season upon us, it might be a good time to talk about put options. If a trader buys a put option, he or she has the right to sell the underlying at a particular price (strike price) before a certain time (expiration). If a trader owns 100 shares of stock and purchases a put option, the trader may be able to protect the position fully or to some degree because he or she will have the right to sell the stock at the strike price by expiration even if the shares lose value.

A lot of traders especially those who are just learning to trade options can be smitten by put options especially buying the shortest-term, or front month put for protection. The problem, however, is that there is a flaw to the reasoning of purchasing front-month puts as protection. Front-month contracts have a higher theta (time decay) and relying on front-month puts to protect a straight stock purchase is not necessarily the best way to protect the stock. If you were to continually purchase front-month puts as protection, that can end up being a rather expensive way to by insurance.

Although front month options are often cheaper, they are not always your best bet. The idea may be sound, the trader purchases a number of shares of the stock and purchases out-of-the-money puts to protect his or her position; but sound reasoning does not always lead to good practice. Here’s an example.

We will use a hypothetical trade. The stock is trading a slightly above 13 and our hypothetical trader wants to own the stock because he or she thinks the stock will beat its earnings’ estimates in each of the next two quarters. This investment will take at least six months as the trader wants to allow the news events to move the stock higher.

Being a smart options trader, our stock trader wants some insurance against a potential drop in the stock just in case. The trader decides to buy a slightly out-of-the-money October 13 put, which carries an ask price of $0.50 (rounded for simplicity purposes). That 0.50 premium represents almost 4 percent of the current stock price. In fact, if the investor rolled option month after month, it would create a big dent in the initial outlay of cash. To be sure, after about seven months (assuming the stock hangs around $13) the trader would lose more than 25 percent on the $13 investment.

If the stock drops in price, then the ultimate rationalization for the strategy is realized; protection. The put provides a hedge. The value of the option will increase as the stock drops, which can offset the loss suffered as the stock drops. Buying the put is a hedge and and a solid insurance policy – though, albeit, an expensive one. Investors can usually find better ways to protect a stock.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

September 13, 2012

To Buy Puts or Not to Buy Puts…

Filed under: Uncategorized — Tags: , , , , , — Dan Passarelli @ 10:36 am

A lot of traders especially those who are just learning to trade options are enamored by the all mighty put – especially buying the shortest-term, or front month, put for protection. The problem, however, is that there is a flaw to the reasoning and practice of purchasing front-month puts as protection. Ah, yes; it’s true. Front-month contracts have a higher theta – and relying on front-month puts to protect a straight stock purchase is not, necessarily, the best way to protect an investment. If you were to continually purchase front-month puts as protection, that can end up being a rather expensive way to by insurance.

Although front month options are often cheaper, they are not always your best bet. The reasoning may be sound, the trader purchases a number of shares of the stock and purchases out-of-the-money puts to protect his position; but sound reasoning does not always lead to good practice. Let’s take a look at an example.

We will use a hypothetical trade today. The stock is trading a slightly above 13 and our hypothetical trader wants to own the stock because he/she thinks the stock will report blow-out earnings in each of the next two quarters. This investment will take at least six months, as the trader wants to allow the news events to push the stock higher.

Being a savvy options trader, our stock trader wants some insurance against a potential drop in the stock. The trader decides to buy a slightly out-of-the-money July 13 put, which carries an ask price of $0.50 (rounded for simplicity purposes). That 0.50 premium represents almost 4 percent of the current stock price. In fact, if the investor rolled option month after month, it would put a big dent in the initial investment. To be sure, after about seven months (assuming the stock hangs around $13) the trader would lose more than 25 percent on the $13 investment.

What if the stock drops? That is the ultimate rationale for the strategy in the first place: protection. The put provides a hedge. The value of the option will increase as the stock drops, which counterbalances the loss suffered as the stock drops. Buying the put is a hedge, a veritable insurance policy – though, albeit, an expensive one. Investors can usually find better ways to protect a stock.

Learn a better way to hedge with this FREE options report.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

May 27, 2011

To Buy Puts, or Not to Buy Puts…

Filed under: Options Education — Tags: , , , , — Dan Passarelli @ 3:20 pm

A lot of investors are enamored by the all mighty put – especially buying the shortest-term, or front month, put for protection. The problem, however, is that there is a flaw to the reasoning and practice of purchasing front-month puts as protection. Ah, yes; it’s true. Front-month contracts have a higher theta – and relying on front-month puts to protect a straight stock purchase is not, necessarily, the best way to protect an investment. If you were to continually purchase front-month puts as protection, that can end up being a rather expensive way to by insurance.

Although front month options are often cheaper, they are not always your best bet. The reasoning may be sound, the trader purchases a number of shares of the stock and purchases out-of-the-money puts to protect his position; but sound reasoning does not always lead to good practice. Let’s take a look at an example.

We will use a hypothetical trade today. The stock is trading a slightly above 13 and our hypothetical trader wants to own the stock because he/she thinks the stock will report blow-out earnings in each of the next two quarters. This investment will take at least six months, as the trader wants to allow the news events to push the stock higher.

Being a savvy options trader, our stock trader wants some insurance against a potential drop in the stock. The trader decides to buy a slightly out-of-the-money July 13 put, which carries an ask price of $0.50 (rounded for simplicity purposes). That 0.50 premium represents almost 4 percent of the current stock price. In fact, if the investor rolled option month after month, it would put a big dent in the initial investment. To be sure, after about seven months (assuming the stock hangs around $13) the trader would lose more than 25 percent on the $13 investment.

What if the stock drops? That is the ultimate rationale for the strategy in the first place: protection. The put provides a hedge. The value of the option will increase as the stock drops, which counterbalances the loss suffered as the stock drops. Buying the put is a hedge, a veritable insurance policy – though, albeit, an expensive one. Investors can usually find better ways to protect a stock.

Learn a better way to hedge with this FREE options report http://markettaker.com/free_report_options_traders/

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