The second quarter has arrived with earnings season in full swing, causing tremors in the investment landscape. Recent weeks witnessed seismic post-earnings shifts, notably from tech giants like Meta Platforms, Spotify Technology, and Tesla. Investors now await the Federal Reserve’s imminent interest rate decision, poised to inject further volatility into trading. However, fear not; we delve into how traders can wield options to safeguard their gains.
Unlocking the Protective Put Strategy
One method for investors to shield their positions and cap potential losses amid significant downward movements is through protective puts. Operationalized as a protective mechanism, a protective put fixes a selling price (the strike) for shares in anticipation of adverse market turns.
For instance, envision owning 100 shares of Stock XYZ at $100 each, now valued at $120. Anticipating an impending earnings report that may erode these gains, you can procure a 110-strike protective put covering the earnings period. Should XYZ regress to $100 post-earnings, the put allows divestment at $110, guaranteeing a 10% profit (minus put costs).
A protective put buyer’s primary aim starkly contrasts that of a conventional put purchaser. While a protective put buyer applies options as a safety net against stock declines, their principal objective remains stock appreciation, aiming to offset option expenses and render the put redundant. Conversely, a standard put buyer hopes for underlying shares to decline.
Evaluating the Perils
Although a protective put buyer’s aspiration involves relinquishing the initial put premium (representing maximum risk), the pivotal concern remains avoiding overpayment. Thus, discernment is crucial when selecting the appropriate strike and options series tailored to individual risk thresholds.
Venturing into options trading amidst impending events like earnings necessitates cognizance of escalated options premiums. Pre-event, out-of-the-money puts may offer budget-friendly acquisition avenues but provide diminished safeguarding efficacy.
Moreover, the protective put cost correlates with time value. A 110-strike put expiring in two weeks outlays less than a two-month equivalent, as lengthier durations grant greater leeway for substantial stock movements.