Education Day: Portfolio Protection Alternative Approaches to Mitigating Risk | Cameron May

s Cameron may and today we are talking about portfolio protection. I think this is gonna be an interesting to sessions discussion consider particularly considering markets when pulling back through the late weeks of September moving into October we’ll talk about what we saw last week on a particular last year on a particular stock. But let’s set an agenda for today first of all. The discussion for the day portfolio protection using alternative approaches to mitigating risk now their number different ways or that an investor might might to mitigate the risk on an individual position or a portfolio today and we’re going to be using options now for some of you this is going to be very new. I’ll try to go to pace and everyone can follow very first thing we need to do though so is. Consider the risk of our trading so some important information the following presentation is for educational purposes only options are not suitable for all investors with the protective put strategy while the long put provide some temporary protection from a decline in the- price of the corresponding stock. This does involve risk in the entire cost of the put position. Covered call strategy can limit the upside potential of the underlying stock position. The collar strategy involves risks of both covered calls and protective puts. And in order to demonstrate the function of the problem of the platform we will be using real examples in today’s discussion that is not a recommendation or endorsement of a particular security or strategy. As any investment decision you make in your self directed account is solely your responsibility. All right so let’s kick things off first with a quote here. By fund manager Peter Lynch. He says. You get recessions. You have stock market declines if you don’t understand that’s going to happen. Then you’re not ready you won’t do well in the market so. At a prepared investor. Should probably have a plan for what they’re going to do with their portfolio or individual positions with not within those portfolios when they begin to have a suspicion. That the decline may be imminent. Now again could be any number of reasons why they might think that it at a Klein is coming it might be something they see on the chart his book that might be something. From the company’s performance maybe that companies industry is rotating out of favor. Or economic conditions overall seem to be changing so whatever those conditions may be here is we’re gonna learn today. Today you’re gonna learn to identify potential strategies to help protect your portfolio indoor intuit individual positions that’s more of what we’re gonna focus on. In the event of A market downturn. Now we’re going to cover these next two bullet points use we’re going to introduce to how you introduce you to how to use protective. Puts and- given understanding of callers this bullet point the fourth bullet point. I’m actually prepared another webcast to cover that one so that’s not going to be at directly addressed in this one I’ll give you a little bit of a sample of it. But then a reminder that I actually in my- October third. Vertical it well in my selecting an option strategy webcast on our trader talks webcast from TD Ameritrade web channel you can our YouTube channel. I dedicated that session to a coverage of using long put verticals for hedges so I’m gonna suggest that you check that out but we are gonna be placing some orders on paper money so that you you see not only the theory but also the application up to and including how to get the trade entered. All right so let’s get straight to it now I have a slight prepared for what our protective puts but we’re gonna circle back to this after looking at a real example. So let’s navigate over to our thinkorswim platform. And I want to take a look at at what’s been happening with apple. All right. This as you can see right now apple is pushing up to two hundred twenty six dollars. Getting very close to all time highs back here at two hundred thirty three. So an investor. Particularly a technical trader of apple may say boy since the first of the year. Apple’s been making some significant headway that can look for a bullish but do you suppose. Anyone it was invested in or considering investing in apple might be looking back and saying yeah but look what happened. Last October third seems to be quite timely. We hit the all time peak on apple and it sold off. All the way down. About almost 40% We son almost 40% retracement in that value of apple might that be at the front of the minds of some investors in our potential investors in. Apple well yeah so that’s sort of information might cause an investor to say you know what maybe I’ll hold off on a position but what a four already. Does that require that we then go to cash if our concern is. That we might be pulling back in the near term. Or is there some way. That an investor might hedge the position reduce the short term risk on the position. While remaining in the shares. That’s a possibility. And one may it one way that might be accomplished as through the usage. Of what we call. A protective put now this is an option. So I’m gonna go to the trade tab for apple. And I’ve already typed in the symbol here but to get it that similar look to your own platform you just type in the symbol. And we’re presented immediately with something called the option chain. Now if you’re not familiar with options options can have a bit of a reputation for being. A complicated or scary or risky the in you certainly want to understand any new strategy before applying it right that just makes sense. So let’s try to get you acquainted with options just as quickly as we can. So what we’re seeing here are contracts that we can get into with other investors. And here’s the concept of what we what we might be shooting for here. With apple maybe teetering right there on the edge of all time highs might go higher might go lower we’re not comfortable with the possibility that might go lower. Well what if we were in a contract already where we haven’t sold apple but we have the right to sell our shares of apple for a short period of time. Just in case we need to. Well that’s one option is. I’m gonna go out you’ll notice that there are some contracts that expire very quickly they’re different very short periods of time. Out to contracts that can last up to in this case eight hundred and forty days. Let’s just say we need to get through what we see as a potential rough patch for the next month or so I’m gonna go here to maybe these. These contracts extending through the fifteenth of November they they’re good for forty two days. I’m going to open that up and let’s focus on the put side of the equation over here. So to do that. It says filter. We’re seeing both call options and put options being displayed currently I’m gonna change this to just puts. So it gives us a better easier view of what’s going on all right so for those of you who are new to options. Here’s what we’re doing we’re considering getting into an agreement with another market participant. We’re in we’re going to pay them ed it’s actually an incentive to agree to buy our shares from us at a specific at a specific price. For a specific period of time we can sell it to them at any point. Until this contract is over so that’s for forty two days. So since the stock is trading right here at two hundred twenty six dollars what if we were to give this a little bit of wiggle room to the downside. And what if we were to look at something like let’s say the two hundred and ten dollar put you’ll notice it says strikes let’s talk about the terminology of the contract for just a moment so as we get into this. A few terms we need to be aware of a few a few elements of the contract we need to be aware of for an- option. Typically an option represents. One hundred shares it’s a contract between two market participants where they’re agreeing to exchange shares at a fixed price. Perfect grade of time. But a hundred shares specifically with rare exceptions. All right. So the elements are. In this case when we’re buying a put it gives us the right to sell one hundred shares of stock in this case it’s apple. At any time for the next forty two days that’s the expiration. Of this contract. We’re paying a premium to another investor as the as the incentive for them to agree to enter into this contract with us and in this case it looks like that’s somewhere between three dollars and fifty five cents and three dollars and sixty cents per share. Then and finally an element of this contract we need to remain aware of is that this is transferable so if I. If I buy this option. I have the right to sell my shares to someone else for a fixed period of time if I choose to sell that right. At any time before expiration I do have that as an option to me. So we’ve already covered some of the terminology we have premium we have strike the strike is a price at which we struck a deal. During my exchange those shares in this case to two hundred ten dollars. We know what the premium means. And so let’s. Let’s examine how this might benefit our position and in order to really explore that I need to go a step further and start to talk about something called option Greeks you may not be aware of what those are I’m a pop up here to the lay out above the option chain. I’m gonna switch that to delta gamma theta Vega don’t be too intimidated I realize it can sound intimidating when we’re using something called Greeks second sound like we’re taking big logical step really. It’s not. Too terribly complicated least in my view. But as we’re buying this put. Bottom line what we’re considering doing is paying somewhere between three dollars and fifty five cents and three dollars and sixty cents per share. In a bid to another investor and in exchange we then have the right to sell our shares for two hundred ten dollars to them. At any time between the fifteenth between on the fifteenth of November so if the stock falls. I think you can see how that could be an advantage. In that event right were hedging that position. Well we need to talk about. Two different ways that this could had to position number one is if the stock does fall okay we have the right to sell our shares at two hundred ten Bucks so if it falls to two hundred if it falls to two one ninety if it falls to one eighty doesn’t matter for the next forty two days we have the- contractual right. To sell shares for two and a ten dollars now it may not be that we ultimately want to sell those shares. If the stock falls let’s say it doesn’t fall down below to ten. It might seem that we waste our money but not necessarily even the act of the stock falling can increase the value of this contract. Imagine if you have a contract to sell the stock at a certain price of the stock is falling rapidly in that direction. That contract may become more marketable at a higher price to other market participants who may need that same protection. So as price falls it can theoretically at least drive up the value of the contract. Long as a contract has some time left on it. So there are three variables that an options trader mobile keep in mind that our primary determinants of the overall value of this contract we just paid three dollars fifty five to three dollars and sixty cents. Per share for the contract. And that value can fluctuate if it fluctuates up. That can potentially offset some losses if the stock were to go down. Right so one of the three variables the three variables are price time and volatility. As the stock price moves up and down particularly as it moves down that can increase the value of a contract that has a locked in sales price I think that makes sense. As time goes by on a forty two day contract we’re getting less and less days of protection that can negatively influence the value of the contract. And as a stock becomes more or less volatile well there’s going up or down if it’s moving around a lot. The demand. For protection on shares of that stock may go up. And so an increase in the stocks volatility can also increase the value of current contracts on those shares so price time and volatility. Well wouldn’t it be nice to know how much can those increase those three variables increase or decrease the value of this put contract well that’s where we might use our option Greeks. Delta theta Vega we’re gonna set gamma side out of this discussion for the moment although we have webcasts throughout the week that go that take deeper and deeper dives. Into options trading so if you feel like you’re brand new to options if this discussion is already cause you to. Get a little bit. ANSI you may want to check out barb Armstrong’s class should he does every Friday called getting started with options if you’re more advanced you may want to check out a webcast we do on Thursdays it’s called advanced option strategies as taught by Ken rose three o’clock eastern standard time barb’s class eleven o’clock eastern standard time you can attend those live or you can check out the archives. We archive those on our website and also on our YouTube channel the- trader talks webcast from TD Ameritrade. All right but let’s explore delta theta and Vega delta. Helps us measure how much would this put investment because that’s what this is what we’re spending three fifty five three sixty. Per share on her shares that be let’s just call it three dollars sixty cents per share on her shares three hundred sixty dollars. Well the value of that investment can go up or down one of the influence one of the influences is price is price and that’s measured by delta delta starts with D. so does dollar so this is showing us how much a one dollar fluctuations up or down in the value of apple. Could influence value of our investment so if we look at this to what we say the two ten contract. All right. You know what yeah I’m a stick with that. Let’s look at our delta that delta is twenty three. What that’s telling us is that if the stock were to go up. In this investment is actually better. Than did the value of the put increases if the stock goes down well stock goes up. We might see in negative impact two or three dollars or three hundred sixty dollar. Investment about twenty three cents per share or twenty three dollars. If the stock goes down. Then this put. Theoretically benefits from that to the tune of about twenty three dollars so. Imagine if we own the stock. And we only put the stock goes down a dollar we lost a dollar on the stock. But we’ve made theoretically twenty three cents on the put. So we’ve offset about 23% of that initial. Damage done by the stock price moving downward. And actually if it continues to move down once it gets down below to ten. The we’re contractually the we can essentially see a stop to the bleeding on the stock. Does that make sense. Because the put has to we’ve we’ve locked in a selling price we know that we can contractually self for those shares sellers shares for not a penny less than two ten. Course it came at a cost we had to pay three dollars and sixty cents. So even if we did sell. Two ten minus three sixty. But to sixteen forties about the that now the worst case out come on this trade. All right but that’s our delta theta measures this contract exposure to time decay we bought it with forty two days as each day goes by it lose a little bit of its value. And we can see that value ticking away right here. Data starts with D. so does time. One day going by cost about nine cents of the value of this contract assuming the other variables hold constant. And then finally Vega is twenty four cents. Meaning if the volatility of the stock were to pick up toward one percent. It’s quite likely demand of options will go up and drive prices up and on this contract about twenty four cents. So this starts to help us understand. The variables in the protection of the put and how. How it can. Grow or shrink based on those three things price time and volatility. All right so I think you can start to see at least how we might establish a hedge by buying a protective put. So I want to go back to our slide deck and just revisit these concepts a little bit. Being in a little bit more structured fashion so what are protective puts well that’s when we only long stock and we bought a long put. To help to offset that that. Downside exposure long here is kind of a brokers the term it means that we bought something to establish a position when we buy a stock. We when we buy stock to initiate a stock position we say that were long that stock when we buy an option. We say that were long that option. But the purpose of the put is to define the risk the long put gives a trader the right to sell at the strike price. This net position. Stock ownership plus put is still a bullish position. Because if the stock goes up. And actually as we saw with our delta. Stock let’s say the stock goes up a dollar. Okay we’ll stock makes a dollar we own the stock we have an unrealized gain in the dollar. The put though we saw a delta of twenty three cents that means that we might have a loss an unrealized loss on that put contract until we sell it. Is suing that prices and continue to rise. Of twenty three cents. So net how do we do seventy seven cent game we might say that we have a seventy seven. Net delta. On that position still positive. This net position is time sensitive because their days on the contract decay by we call that theta negative. And that put contract can grow. If volatility increases remember if volatility rises that tends to have a positive impact on the pricing of options. Now finally delta may be used as a guide in the selection of the put. As we’re looking at the option chain and it might be helpful here to flash back to that option chain you may notice that as you go for a larger delta. This is providing more protection on the trade but what’s happening with the value of the puts now the cost is going to be greater so let’s say I wanted a delta of forty six meaning if the stock were to fall a dollar I get forty six cents worth of initial protection. Well that comes at a greater cost than what we were eyeballing up here maybe that to ten set up paying three dollars sixty cents per share might be eight dollars and thirty cents per share. As we go for lower deltas well the cost is less. But we also have less protection. Look at this as we go for lower delta is it means that we are obligating ourselves well not obligating ourselves we have the right to sell the shares still. But at lower lower prices. Okay so what some investors will do is they’ll use that. As a gauge for which delta to choose but- overall delta may be used as a guide. For example of put delta thirty reduces the initial net position rest 270% of the same simple stock ownership where we have a net delta of seventy in our- in our case it was twenty three. So we had a net delta of seventy seven. So quick recap of the pros and cons of this strategy. The pros are we help to define the risk decreases the directional exposure of the trade and the long put can benefit if the if volatility were to increase. The cons though long put does come to cost in this case it’s three dollars and sixty cents per share or three and sixty dollars for the contract. It could expire worthless and that just adds to the average price of the stock so let’s talk about expiration for just a moment let’s suppose. We have purchased this put the gives us the right to sell for two ten. If the stock is above. To ten to fifteen to twenty to thirty doesn’t matter where it’s above to ten. And we get to. To the fifteenth of November forty two days from now. Do we have an incentive. To exercise our right to sell it to ten if the stock is worth more than that we just sell it on the open market for at a greater value. Now that contract. Could just expire worthless. On the flip side of that coin if the stock is below to ten. Now we may have that incentive let’s say it’s a two hundred. One ninety one eighty. Anywhere below that we have the right to sell. For two hundred ten dollars. Do we have a motivation to that yeah and that case we may choose. To assign either up to. Or at expiration at expiration though. If the stock is trading below to ten. And we haven’t exited the trade by selling the option. Then. The contract will be exercised in those shares will be sold. Because it’s effectively at that point it would be in our best interest to do so. But also this contract is time sensitive. We know that let’s go buy a protective put. So within our paper money account here you’ll notice there’s a hundred shares of apple just one hundred shares of so let’s just do one contract them to go back to that trade tab. Let’s go to our to ten put. And to put in the order it really just go to the ask price. And click on that. And that creates in this paper money account. A default of ten contracts that would be two heads. A thousand shares. Let’s reduce that to just one contract. And you know I believe this is a limit order. Which means I’m requiring that I pay no more than three dollars and sixty cents per share. But let’s click confirm and send. And there are still transaction fees that we need to consider buying that one apple put. At a three sixty limit. And I’m gonna click send that’s how it’s not. Bought that put okay so now. In revisiting are pros and cons I have a question. Do we have are we just obligated is the only way to hedge the position to take. A to make a large investment on a put or comparatively large investment are we- required. To have that time sensitivity or is there some way that this strategy might be additionally customized. To reduce these two cons. Possibly there’s another strategy that’s known as a caller so what is a caller well it’s gonna look bright quite similar long stock check long put put check but then a short call. Now those of you have some experience with with options. What are your further this as when we have a long stock and we sell a call against that. That’s actually covered call and sometimes a trader we’ll use the income received a credit received from a covered call to offset the expense of buying that put. All right the purpose of this still to define the risk. But at a lower net cost so again we’re still defining the rest were trying to hedge the position the put provides a contractual selling price so we still have a as in our example. The right to sell. For two hundred ten dollars. But that because of the call. Maybe helps offset the price of that put. This generates still a bullish position it’s gonna be a delta posit position that’s essentially time neutral because- time theoretically works against buyers and for sellers will in a caller where we have a long put we own a put and we have sold a call. Where a buyer and the seller. So time is really working for one position against the other position that’s generally effectively neutralized. And it’s also volatility neutral as volatility goes up that theoretically theoretically typically helps buyers of options it can harm sellers of options this position is both. All right but the bottom line here is for every hundred shares a typical caller might have in that delta of twenty to forty of remember. On our other trade we had a net delta seventy meaning if the stock goes up. And actually in our in our example is more like seventy seven. But if the stock goes up we stood to make seventy maybe seventy seven cents per share on that position in this case. If we do this caller you notice something. You don’t make as much. Because you’re also not as exposed to loss on this trade it’s a trade off once again. So let’s go look at an exit an example of a caller if you didn’t quite follow that logic let’s explore it. So here’s our apple position we already own this put so what a trader might do here I’m gonna come up here where it says sides again let’s just switch this right back to both. Let’s look at a call. Now call instead of being when we sell an option. Instead of having the right to do something. We’re gonna have the obligation to do something with a call specifically. We’re giving someone else the right to buy our shares from us. So we have the right to sell our shares at a specific price but someone else has the right to buy our shares at a specific price so we’re going to hedge in the position effectively. Now I’m going I am going to use delta as a guide here. Let’s look for a delta that’s similar in this case to the delta that we had with our long put. And I’m going to choose let’s maybe sell the two forty call. Let’s talk about what’s happening here. What we’re doing is accepting a payment from another market participant around three dollars I’m gonna use three dollars even though it’s a few pennies off about that but just for. Just for conceptual purposes to make the math easy. Let’s say someone else is paying us about three dollars per share on a hundred shares. That’s three hundred dollars. They’re giving us three hundred dollars not all the good the goodness of their hearts but in exchange we’re giving them a contractual promise. That other trader now has the right. To buy shares from us. For two hundred forty dollars. With the stock being right here at two twenty six that means if the stock were to go up. Long as it stays below two forty. We’re getting that three hundred dollars as just helping helping us to offset the value of the cost of the put. If we go above two forty. Any growth beyond that is going to the other investor. But essentially what we’ve done is we’ve collared that position think about a caller goes all the way around. And I think you can see how. In this case we’ve colored the stock price. Stock prices here at two twenty six we have the right to sell for two ten. We have an obligation to sell for two forty. But can you start to see how this may benefit the trade. Now instead of being three dollars and sixty cents out of pocket. We’re only effectively sixty cents out of pocket. If the stock collapses we still have the right to sell for two ten. End we’ll have to offset about sixty cents. Of investment so if we did wind up selling the shares for two ten. We’ve only got another sixty cents invested in our caller. So really the worst case outcome here is about two dollars and our two hundred nine dollars and forty cents. As as a worst case scenario it would be if it would be as though we sold it to a nine forty. So that selling of the covered call. Primary purpose was to help fund the purchase of the put and for a lot of investors these are typically done at the same moment on the same trade now what we’re doing these. Separately just so you can see this being done. Now. Let’s go back and revisit the pros and the cons of this strategy. So the pros and cons of a Kahler decreases the directional exposure to volatility. Because now we have to bearish trades. To offset the bullishness of the stock when we wanna stock were bullish. When we only long put that is a bearish position that that theoretically benefits of the stock goes down when we sell a call that’s also a position. There realizes maximum potential if the stock remains below the strike price so to bearish positions offsetting the bullishness of the stock that potentially protects profits and hedges if the short term trend is now short term being key here because both of these are only good for forty two days. The cons are there can be an increase in transaction fees. There is an obligation to sell a style that sell the stock at the call. Price and- the duration of protection is limited to the time frame of the contracts. All right so let’s go ahead and put on that color. Since we already own the stock we already own the put all we have to do now. Is go to our selected strike price. And click on the bid price look at that it’s moved conveniently right to three dollars. Let’s see if we can get exactly three dollars. We need to make sure that the quantity matches. Let’s put this in for it just one contract. And I’m a confirm and send this order selling that one November that the fifteenth of November call for three dollars. Of course transaction fees are still consideration. I’m gonna send that order off and looks like we sold that immediately all right so paid three sixty for the put no. So we’ll pay for it. I don’t recall this weekly check it we go to our monitor page open up our apple position we can actually click right on the quantity for that put. Yeah we pay three sixty four it. So we did fill at three sixty. We recieve three dollars on the call so mad we paid sixty cents. For this protection. We have the right to sell it to ten if the stock goes. Racing up though also obligated to sell at three forty. So we’ve actually accomplished what we set out to do. We’ve examined. How is it investor might hedge a position with a long put how an investor might also had to position using a caller this is not a sales pitch for either one of these but it may be time to start experimenting with these strategies if you find them intriguing you can go to your paper money portfolio and I have a suggestion for you in just a moment but- here’s what we’ve learned. We’ve identified some potential strategies to protect your portfolio and or your positions in the event of A market downturn. We now know how we might use protective puts. Out we now understand what colors are we have an archive session already ready to go for. The application of long put verticals. And we’ve placed virtual orders on thinkorswim paper money. So now the ball’s in your court I think when learning when a concept is fresh. Sometimes you can feel like you have a really solid grasp of it but if it’s not put into practice. That learning can be lost quickly I think everybody’s experience at from time to time. So I would suggest you apply what you’ve learned review some stocks that you own. This could be in your paper money account or you might consider buying puts on them for protection. You can also practice placing a caller trading finally I’m more men this final bullet point. If we don’t know what long put verticals are yet you want to go check out my. My October third webcast. And it’s called selecting an option strategy but in that webcast we decided to cover long put verticals and how those might be used as hedges so that would give you a third strategy that might be. Employed when you see maybe some troubled waters ahead. Are you ready thanks for joining me today I hope you enjoyed that pres and Tatian if you’d like to follow me on Twitter my handle is at C. for Cameron at C. may and may why. Underscore TDA. I try to tweak something every day of the week it’s always my pleasure I like to communicate so whatever platform available to me but on Twitter specifically. Try to make smart market observations are I try to give you some personal information all of our coaches can be found using ace more template for their- handle. At first initial last name underscore TDA. A time for me to set you loose. Thanks for joining me quick reminder risks are real use real examples in today’s discussion is not a recommendation or endorsement of those securities or those strategies. Enjoy the rest of your day. And whenever I see you again until that moment arrives I want to wish you the very best of luck happy investing bye by

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