Author Topic: Can we talk about puts?  (Read 1753 times)

SmileAllDay

  • Stubble
  • **
  • Posts: 112
  • Traveling full-time with my wife since '16.
    • So, where were we?
Can we talk about puts?
« on: September 13, 2022, 01:04:40 PM »
Hey everyone.

I've been a diehard indexer for about 5 years. Investing roughly 60% of my earnings.

By all accounts, we are in for a bad ol' time as investors during the next (year... 18 months... 3 years... whatever the case may be). This is my first bear market.

I don't wanna cash out my chips but I think it could be worth buying some just out-of-the-money puts, to hedge my long positions.

Are any of you doing this? Or, to be more blunt:

Have any of you done this successfully over the years during market downturns? I would be so grateful for you thoughts and advice.

Thanks!

ChpBstrd

  • Walrus Stache
  • *******
  • Posts: 6751
  • Location: A poor and backward Southern state known as minimum wage country
Re: Can we talk about puts?
« Reply #1 on: September 13, 2022, 01:44:28 PM »
Puts are like insurance policies. They cost money, are in effect for a limited time, and can save your @SS in the event of an emergency. They also vary in price from time to time.

Consult this resource to beef up your knowledge. The OIC has lots and lots of other educational content on their site. It's definitely a learning commitment, but very worth it! ONLY ever consider high quality information sources when educating yourself about options, because social media is full of dipshit clickbait "influencers".
https://www.optionseducation.org/strategies/all-strategies/protective-put-married-put?source=ff07eb67-094d-45a8-a0cd-ed2a948c063d

Also bear in mind that you can get the exact same risk/reward profile with a long call option as you can get with a protective put. This matters now because long calls are a lot cheaper than stock + long put options, and we now have treasuries yielding 3.5%+ and things like I-bonds where you can invest the rest of your cash and earn decent interest. Of course, due to a phenomenon called put-call parity, any arbitrage opportunity is supposed to be priced in - but do the math anyway.
https://www.optionseducation.org/strategies/all-strategies/long-call?source=0b204a45-439e-404e-97a4-71ec2c64eb61

An option's price consists of intrinsic value + time value, and these two sources of value trade off with each other due to daily market movements. Make sure  you understand this point and the concept of delta so that you can predict what will happen to your hedged position in the event of a big downturn. I.e. if you own a stock worth $100 and a put option with a few months of duration at the $100 strike, what happens to the price of the put option if the stock goes down to $99 tomorrow? The answer is NOT that it moves dollar per dollar with the stock. It will probably go up about 50 cents when the stock goes down $1. This was an eye-opener to me when I was a noob.

Keep an eye on the VIX index, which is a measure of market volatility calculated from the amount of time value present in index options. When VIX is relatively high - like today at 27.4 - you are paying a higher price for the time value component of options, and your option can lose value if volatility decreases - even if the stock didn't go anywhere! If you pay a higher price for time value, expect the value of your long option to decrease more rapidly due to time decay.

Bottom line: You need to devote a few hours to learning options. But IMO it's very much worth it because you can hedge your positions and not get shaken out by the next correction.

SmileAllDay

  • Stubble
  • **
  • Posts: 112
  • Traveling full-time with my wife since '16.
    • So, where were we?
Re: Can we talk about puts?
« Reply #2 on: September 13, 2022, 02:02:28 PM »
Well if that isn't the best damn reply I've ever seen!

Thank you.

I've put in quite a few hours already, and have plenty more to dedicate. I'm conscious of my lower-than-average math skills so I'm trying to get my head around it.

Gremlin

  • Pencil Stache
  • ****
  • Posts: 581
Re: Can we talk about puts?
« Reply #3 on: September 13, 2022, 06:21:37 PM »
I haven't seen it done well, but I have seen it done badly.

First of all, if you choose to do so, be aware that you are timing the market.  You are taking a bet that you can predict the performance of the market better than the consensus of the market over a pre-defined period. 

Second, your second line highlights the key dilemma you have.  "we are in for a bad ol' time as investors during the next (year... 18 months... 3 years... whatever the case may be)".  Options come with a timeframe, and as @ChpBstrd says, those timeframes are priced differently.  I had a friend in 2006-2007 who was convinced that a sharemarket crash was imminent.  He bought a 3 month put to protect his portfolio.  It expired out of the money.  He bought another 3 month put.  It expired out of the money.  He bought a third 3 month put.  It expired out of the money.  He bought a fourth 3 month put.  Again, it expired out of the money.  He became disillusioned with losing money on puts and didn't purchase a fifth put less than a month before the market topped.  He lost a lot more than he would have had he just rode it out.

If you do this, you need to have an idea of what you are trying to protect, how much you are prepared to spend to protect it, over what time period and why?  If you can't legitimately answer these questions, then it may not be the right decision.  You've said that 'you don't wanna cash out my chips'.  Buying just out-of-the-money puts is, in effect, cashing out some of your chips, since the put needs to be funded somehow.  It's either from selling down some of your portfolio or using money that could otherwise be used to invest elsewhere.  Don't kid yourself that this strategy doesn't cash out chips. 

Third, it's worth understanding the tax implications.  I'm not in the US, so the tax rules for me are going to be different to the tax rules for you.  But I do know that I can construct an underlying portfolio or a synthetic portfolio that will have exactly the same market exposure, but will have very different tax implications.  At least in my jurisdiction, options make tax quite complex and can create a tax liability in the current financial year, even if the money you make from exercising the option doesn't land in your bank account until much later.  That can cause problems from a cashflow perspective if you're not aware of it.  So it's worth understanding whether you 'win' on your put, but 'lose' overall after tax (or vice versa, even).

Fourth, be aware that protected puts work well against a short, sharp fall in the market (eg a 'Black Tuesday' crash).  They won't necessarily protect you against a long, slow market decline.  You can potentially be right about a falling market, but wrong about the mechanics of it and still lose money.  You'll probably lose more than those who don't buy puts in this circumstance.

Finally, one thing to consider, if this is your response to your first exposure to a falling market, is whether your overall asset allocation allows you to sleep at night?  If it's stressing you when you face the first prospect of a falling market, then maybe it's too heavily geared to stocks over bonds?  A simpler, and possibly more sustainable, strategy might be to move some of your assets to be more defensive, to a point where you're comfortable with the prospect of a share market crash, you can shrug your shoulders, and continue to dollar cost average your way to early retirement.
« Last Edit: September 13, 2022, 06:25:48 PM by Gremlin »

Heliios

  • 5 O'Clock Shadow
  • *
  • Posts: 21
Re: Can we talk about puts?
« Reply #4 on: September 13, 2022, 08:59:25 PM »
We were looking at 6 month 'slightly out-of-the-money' VTI puts last winter because we were considering a home remodel. At the time, the premium was something close to 5% of the strike value, which we decided was a very expensive insurance premium for such a short time period. In general, my experience is that options are very efficiently priced, as in they aren't worth it unless you have insider information.
Even when you do have a premonition, timing is everything. A thought experiment, suppose you had employed this strategy with 6 month puts back in January 2020 because you were reading about Chinese case numbers and feared the worst. When would you have exercised them? After the market fell 10%? After it fell 20%? Or maybe you would have waited until expiration at which point the market had almost fully recovered? The odds that you would exercise exactly on March 23 at the bottom are very slim, so again it is still market timing/gambling.

MustacheAndaHalf

  • Walrus Stache
  • *******
  • Posts: 6665
Re: Can we talk about puts?
« Reply #5 on: September 14, 2022, 05:48:39 AM »
Some posters seem to have missed OP saying "I think it could be worth buying some just out-of-the-money puts, to hedge my long positions."  The goal of hedging is to mitigate losses.

I would encourage OP to consider hedge positions in the money, at the money, and out of the money.  There are tradeoffs with how much money you commit and the "cost" in terms of time value.  Since the market is closed right now, I'll only look at puts within the last hour of trading (9/3 3pm or later).  SPY closed at $393.10/sh yesterday, so I will use that price.  I'll use 2.3 year options that expire Dec 2024.
https://finance.yahoo.com/quote/SPY/options?date=1734652800&p=SPY

$450 strike $74.00/sh:
$450 - $393.10 = worth $56.90/sh
time value : ($74.00 - $56.90) / $393.10 = $17.10 / $393.10 = 4.4%

$400 strike $48.98/sh :
$400 - $393.10 = worth $6.90/sh already
time value : ($48.98 - $6.90) / $393.10 = $42.08 / $393.10 = 10.7%

$350 strike $29.46/sh:
out of the money, $0 intrinsic value, 100% time value
time value : ($29.46 - $0) / $393.10 = $29.46 / $393.10 = 7.5%

The $450 strike is the "cheapest" in terms of time value, but requires the largest investment.  The $350 strike breaks even at around $320/sh, which requires a 19% drop.  So it offers the least protection for someone who wants to hedge their long positions.

ChpBstrd

  • Walrus Stache
  • *******
  • Posts: 6751
  • Location: A poor and backward Southern state known as minimum wage country
Re: Can we talk about puts?
« Reply #6 on: September 14, 2022, 08:36:14 AM »
I haven't seen it done well, but I have seen it done badly.

First of all, if you choose to do so, be aware that you are timing the market.  You are taking a bet that you can predict the performance of the market better than the consensus of the market over a pre-defined period. 

Second, your second line highlights the key dilemma you have.  "we are in for a bad ol' time as investors during the next (year... 18 months... 3 years... whatever the case may be)".  Options come with a timeframe, and as @ChpBstrd says, those timeframes are priced differently.  I had a friend in 2006-2007 who was convinced that a sharemarket crash was imminent.  He bought a 3 month put to protect his portfolio.  It expired out of the money.  He bought another 3 month put.  It expired out of the money.  He bought a third 3 month put.  It expired out of the money.  He bought a fourth 3 month put.  Again, it expired out of the money.  He became disillusioned with losing money on puts and didn't purchase a fifth put less than a month before the market topped.  He lost a lot more than he would have had he just rode it out.

I think an option-hedged portfolio can be maintained indefinitely. It should be thought of as a possible asset allocation. Done right, you can capture most of the upside of a 100% stock portfolio while putting a firm floor on your potential losses, lower your portfolio's volatility, and tolerate a higher allocation to stocks than you could tolerate without protection.

Time decay (AKA "theta") sometimes costs some of one's return, but sometimes that time value transforms into a payoff like a lotto ticket. The value of the time decay you pay, in theory, roughly equals the probability-weighted value of the payoffs you receive in the very long term. The values of options are calculated by supercomputers looking at historical prices, converting these into a volatility number, and solving complex formulas. As long as you stay with the most liquid options market - S&P500 index or SPY for example - it is practically impossible to overpay for an option. Even the ups and downs of price changes due to volatility reflect events that actually change the odds of an option being in-the-money.

Your friend who bought 3 month options and let them expire was doing it wrong, because time decay is not linear, it accelerates as the option approaches expiration (another important concept I learned). An option with a year or two duration decays at a much slower rate than an option with a month duration. Here's a concrete illustration, using this morning's prices:

SPY 390 Oct 14, 2022 put (30 days): $9.75
     daily theta: -$0.1955
     annualized cost of insurance as % of strike price: ((9.75 * 12)/390=) 30%

SPY 390 Sept 15, 2023 put (366 days): $32.14
     daily theta: -$0.0422
     annualized cost of insurance as % of strike price: ((32.14 * 1.003)/390=) 8.3%

SPY 390 Jan 17, 2025 (856 days): $44.50
     daily theta: -$0.0232
     annualized cost of insurance as % of strike price: ((44.50 * 0.4264)/390=) 4.87%

(Note: options are expensive today because of volatility. VIX is about 27. But the point about time decay and duration is similar across all environments.)

So just like at the grocery store, it pays to buy protection in bulk. The longer your duration, the lower your theta. When I'm hedging I prefer to buy a very long duration option - like 2.5 years - and then when there's about a year remaining on that option, I trade it for another 2.5 year duration option. In this way, I can maintain a very low theta indefinitely, wait for days of low volatility to make my trades, and maintain plenty of time before my protective options expire. So using the examples above, if I was currently holding the put with 366 days remaining, I might trade it for a put with 856 days remaining, and pay a net (44.5-32.14=) $12.36 to obtain (856-366=) 490 more days of protection. All things being equal, my new $44.50 option would be worth $32.14 in another 490 days, so my cost of insurance for 490 days is ~$12.36*. That's an annualized cost of (((12.36 * (365/490))/390)= 2.36%. This damn good deal would be even better if my numbers weren't from a high-volatility environment. As you can see, I could roll this strategy forever and earn 2.36% less than the the S&P500 while putting a firm floor on any potential losses below a few percent.

An 88% stock / 12% long options portfolio set up this way looks very attractive compared to a 60/40 or 70/30 stock and bond portfolio, and it will have lower volatility too - more like a 50/50 portfolio in my experience. Most importantly, the stock+option portfolio has a firm limit on the lowest return it can experience, while the other portfolios do not.

In a strategic sense you don't want to have your put option expiring in the middle/beginning of an economic crisis, because volatility will inflate the cost of the next put option you buy. You'd be forced to decide whether to pay high-volatility prices to buy another put and maintain the floor on your losses, or to go without protection at a very risky time (e.g. at the start of a probable recession or financial crisis as volatility is ramping up). Bear markets can last for many months, or years, and you need your put option to carry you across that long gap in time.

The optimal thing is to buy a long-duration put when volatility is low and stock prices are high, and then as volatility increases and stock prices fall, your put gains value. Similarly, it's cheaper to roll your existing put to a longer duration when vol is low. In the grand scheme of things, optimizing these volatility details are less important than maintaining an aggressive asset allocation and not bailing on your AA in the middle of a rough patch. I wouldn't let these optimizing details stop you from adopting a long-term hedged asset allocation now if that's what you want to do. From a sequence of returns risk perspective, if one can dodge most of the damage from the first bear market of their retirement, it is likely the rest of their retirement will be secured.

So basically: Hedging works best when done for the long-term as part of a plan to economize the cost of insurance. Hedging for a few months at a time and riding put options to their expiration date is unlikely to be successful.

*In reality, the price of SPY is likely to be somewhere far away from $390 in a year or a year-and-a-half. If it's higher, e.g. $425, the put you already own will be worth much less and so you'll probably have to contribute more money if you want to protect more of your gains. So maybe you trade a 390 put with one year remaining for a 410 put with two-and-a-half years remaining. This will cost $ but it is comparable to paying more for homeowner's insurance as you expand your house. On the flip side, if SPY is less than $390 in a year or so, say $350, then the put you already own will have multiplied in value as your stock has lost value. Your choices in this contingency are: (1) Sell the put, use the proceeds to buy more stock, and ride un-hedged to the recovery, (2) roll at the $390 strike to continue protecting your original basis, or (3) Trade the put for a lower-strike put, and use the proceeds to buy more shares of stock. It's good to think out one's plan for each contingency. I.e. you *hope* your stock go up over time, but that *will* mean paying more to insure those gains, and if stocks go down will you maintain insurance no matter what or is there some level where you want to drop your hedges and buy the dip or "rebalance" your two counter-correlated assets?

Gremlin

  • Pencil Stache
  • ****
  • Posts: 581
Re: Can we talk about puts?
« Reply #7 on: September 14, 2022, 07:48:43 PM »
@ChpBstrd

I kind of agree, but also disagree, depending on the circumstance.  I don't have a problem with a long-term strategy of equities with long duration puts.  I think it can be effective to mitigate downside risk to a portfolio for exactly the reasons you've outlined. 

I completely agree with trying to hedge the impact of the first bear market post-FIRE (or post-retirement as the case may be).  I'm FI, but SWAMI-ing at the moment, and it's very much a strategy that I'll be considering when I finally stop working.  I see this though as a set strategy over at least the course of a full economic cycle.

I don't think that's what the OP was asking though (I might be wrong, and if so, I apologise), and certainly wasn't what my friend was trying to do.  The way the question was framed, I interpreted it as more about being able to benefit by successfully timing the market as it faces a potential decline, particularly with the comment about not wanting to cash out the chips.  I interpreted that as a short-term play only, which I felt (and still feel) has several potential pitfalls.

For my friend, the tax implications of buying long duration puts were ugly (there's been some tax reform in my country around this since, but some of the rules are still very... baffling).  I appreciate that's unlikely to be the same for you guys, but we each play the cards we're dealt in our own jurisdiction. 

MustacheAndaHalf

  • Walrus Stache
  • *******
  • Posts: 6665
Re: Can we talk about puts?
« Reply #8 on: September 14, 2022, 11:47:27 PM »
@Gremlin - I think you're right about OP.  Other posts show they started investing 5 years ago, and that this could be more about fear than actual hedging.  But I also wanted to ask, what is SWAMI-ing?

Quote
"This is my first bear market.
I don't wanna cash out my chips but I think it could be worth buying some just out-of-the-money puts, to hedge my long positions."
@SmileAllDay - If you were investing for all of 2020, how did you miss the March 2020 market drop?  Maybe that's the key in 2022: ignore the market.  It's a valid strategy to buy whenever you can, and hold until retirement.

If you need money in the next 5 years, you shouldn't be investing that money.

It may also help to read a book like "A Random Walk Down Wall Street" which I've seen in Europe.  That book provides historical data to back up its investment style.  You will see how past crashes and recoveries have played out, which will make 2022 seem a bit more normal.  It can put things into perspective.

Gremlin

  • Pencil Stache
  • ****
  • Posts: 581
Re: Can we talk about puts?
« Reply #9 on: September 15, 2022, 01:07:46 AM »
@Gremlin - I think you're right about OP.  Other posts show they started investing 5 years ago, and that this could be more about fear than actual hedging.  But I also wanted to ask, what is SWAMI-ing?

SWAMI = Satisfied Working Advanced Mustachian Individual

I have the money to FIRE, but I choose to work, on my own terms, as it fulfils certain aspects of personal satisfaction.

ChpBstrd

  • Walrus Stache
  • *******
  • Posts: 6751
  • Location: A poor and backward Southern state known as minimum wage country
Re: Can we talk about puts?
« Reply #10 on: September 15, 2022, 08:00:45 AM »
@ChpBstrd

I kind of agree, but also disagree, depending on the circumstance.  I don't have a problem with a long-term strategy of equities with long duration puts.  I think it can be effective to mitigate downside risk to a portfolio for exactly the reasons you've outlined. 

I completely agree with trying to hedge the impact of the first bear market post-FIRE (or post-retirement as the case may be).  I'm FI, but SWAMI-ing at the moment, and it's very much a strategy that I'll be considering when I finally stop working.  I see this though as a set strategy over at least the course of a full economic cycle.

I don't think that's what the OP was asking though (I might be wrong, and if so, I apologise), and certainly wasn't what my friend was trying to do.  The way the question was framed, I interpreted it as more about being able to benefit by successfully timing the market as it faces a potential decline, particularly with the comment about not wanting to cash out the chips.  I interpreted that as a short-term play only, which I felt (and still feel) has several potential pitfalls.

For my friend, the tax implications of buying long duration puts were ugly (there's been some tax reform in my country around this since, but some of the rules are still very... baffling).  I appreciate that's unlikely to be the same for you guys, but we each play the cards we're dealt in our own jurisdiction.

I'll agree back that doing short-term hedging is market timing. Strangely, most illustrations of hedging in the online literature I've seen is... short term market timing. A common example is to buy protective puts around when earnings are released, presumably on the single stocks you own instead of index funds. WTF? What individual investor would actually do that around every quarterly earnings release date for the 30-50 stocks in their diversified portfolio? And then after buying the fastest-decaying short-duration puts at their most expensive time, you're supposed to go un-hedged the rest of the time? I've seen better advice on WallStreetBets.

The OP states a concern that "we are in for a bad ol' time as investors during the next (year... 18 months... 3 years... whatever the case may be)" so I interpreted that as a desire to set up a long-term hedged asset allocation and to stick with it. There is remarkably little information on the internet about how to do this optimally, so I hope I answered that question in my post.

One thing I forgot to mention:
The strategy I described above can be used to make any gains from put options long term capital gains if you hold the puts longer than one year. Similarly, if your puts have lost value, you can decide to roll right before the one-year mark and make the losses short-term capital losses.

We were looking at 6 month 'slightly out-of-the-money' VTI puts last winter because we were considering a home remodel. At the time, the premium was something close to 5% of the strike value, which we decided was a very expensive insurance premium for such a short time period. In general, my experience is that options are very efficiently priced, as in they aren't worth it unless you have insider information.
Even when you do have a premonition, timing is everything. A thought experiment, suppose you had employed this strategy with 6 month puts back in January 2020 because you were reading about Chinese case numbers and feared the worst. When would you have exercised them? After the market fell 10%? After it fell 20%? Or maybe you would have waited until expiration at which point the market had almost fully recovered? The odds that you would exercise exactly on March 23 at the bottom are very slim, so again it is still market timing/gambling.

I keep looking at the options market for VTI wishing it was more liquid, but it's not. The bid-ask spreads are huge compared to SPY. That means you are only likely to make a trade at price that is worse than the option's fair value, or not get reliable executions when you set your limit price at the midpoint. When your options are far out of the money, you might be unable to liquidate or roll. So I stay away from VTI, VOO, VB and lots of other funds that are technically better than SPY or QQQ. The sad fact is if you want to hedge you will have to pay the minisculely higher ER's of the oldest ETFs or else pay a lot more due to illiquidity in the options markets of the cheapest funds. I try not to let this detail bother me, because the big picture of SORR is what matters.

Your point about "When would you have exercised [the put options]?" is a good one. When the market is going down fast, and your put options are appreciating fast, there is a strong temptation to hold those put options and expect more drops. Things always look shittiest at the bottom, when everyone is capitulating and selling in a wave of pessimism.

If you hold your puts through the bottom, they will start to lose value as stocks recover, and your portfolio ends up right back where it started when stocks return to their original values. That is NOT a bad thing if ...

     (a) the lower portfolio volatility saved you from selling stocks near the bottom in a panic, or
     (b) your retirement withdraws were made proportionally from both your stocks and your put options during the correction, or
     (c) hedging this way allows you the courage to hold a much more aggressive portfolio in the long term.

There is, however, a bolder way to hedge: Write an Investment Policy Statement saying something like "If the market is down 25% or more from it's previous high, I shall sell my protective puts and go with an 90/10 asset allocation for at least the next two years." This is not market timing, because it does not rely on a forecast of the future. The decision relies on conditions occurring in real time. Additionally, such a strategy exploits three assumptions that have proven durable in the past:

     1) When the stock market is dramatically down, volatility pumps up the value of options far beyond their intrinsic value. Your puts will never be more valuable than at the bottom.
     2) When the stock market is dramatically down, the next few years' performance tends to be very good.
     3) Bigger corrections are more rare than smaller corrections, so a -10% correction is more common than -20%, which is more common than -30%, which is more common than -40%, and so on. Wherever your line in the sand is, the odds of the stock market losing another 1% after that line is less likely than the previous 1% it lost. So as the market goes down further and further, so does the risk of more declines.

Even if one completely misses the bottom and sells their puts at -25% when stocks will eventually go -40%, one will still eventually come out ahead of the person who never hedged at all because they obtained significant gains on the puts. In game theory, this would be referred to as a dominant strategy - the choice that leaves you better off than the opposite choice no matter what your counter-party - in this case the market - chooses to do.

The upside is if you switch AA's from hedged to aggressive while stocks are down, you ride the recovery up with more shares than you had before. Also in this scenario, your portfolio isn't dragged down during the recovery by rapidly depreciating puts - which are losing value due to both rising stock prices AND falling volatility AND perhaps falling interest rates too. The puts benefit you before you sell them, and they don't hold back the portfolio in the recovery.

One's choice to ride the hedge all the way through rough spots or to try to exploit them is a personal decision. You won't regret hedging either way if a recession / correction is coming.

Financial.Velociraptor

  • Handlebar Stache
  • *****
  • Posts: 2165
  • Age: 51
  • Location: Houston TX
  • Devour your prey raptors!
    • Living Universe Foundation
Re: Can we talk about puts?
« Reply #11 on: September 16, 2022, 03:19:05 PM »
ChpBstd and M&1/2 have given pretty good advice here.  I'll just add, an allocation to good old fashioned cash is like a call option on the entire market with no expiration date and no theta (unless you count inflation).  If you are having trouble with the prospect of losses and wanting to make the best of the downside, an allocation to 90 day Treasuries fits the bill nicely and doesn't require a ton of specialized trading knowledge. 

dignam

  • Pencil Stache
  • ****
  • Posts: 627
  • Location: Badger State
Re: Can we talk about puts?
« Reply #12 on: September 21, 2022, 01:10:02 PM »
Some great responses already.  Since buying long puts is essentially a gamble/timing the market, you could look at other options strategies too.  If you're still overall bearish on the market, you could sell some bear call spreads; i.e. you sell the near strike short call, buy a slightly higher strike long call with same expiration.  That way, your gains and potential losses are locked in and defined.  You can tweak at what strike and at what expiration to whatever risk you're looking to manage.  This is just an example, but a different way to look at it (bear debit put spreads are another).  For one of my shorter term accounts, I'm long in SPY and have been selling credit spreads on SPY as well.  I always consider the scenario where the market moons past the call strikes, and what "loss" I'm willing to take on the options; yet my long SPY position is still there to soften the blow a bit.

As others have said, keep doing research before you dive in to options.

Financial.Velociraptor

  • Handlebar Stache
  • *****
  • Posts: 2165
  • Age: 51
  • Location: Houston TX
  • Devour your prey raptors!
    • Living Universe Foundation
Re: Can we talk about puts?
« Reply #13 on: September 21, 2022, 01:40:36 PM »
Some great responses already.  Since buying long puts is essentially a gamble/timing the market, you could look at other options strategies too.  If you're still overall bearish on the market, you could sell some bear call spreads; i.e. you sell the near strike short call, buy a slightly higher strike long call with same expiration.  That way, your gains and potential losses are locked in and defined.  You can tweak at what strike and at what expiration to whatever risk you're looking to manage.  This is just an example, but a different way to look at it (bear debit put spreads are another).  For one of my shorter term accounts, I'm long in SPY and have been selling credit spreads on SPY as well.  I always consider the scenario where the market moons past the call strikes, and what "loss" I'm willing to take on the options; yet my long SPY position is still there to soften the blow a bit.

As others have said, keep doing research before you dive in to options.

Bear put spread with a net debit is safer for beginners than bear call spread with a net credit.  As long as a BPS uses cash on hand, no margin is consumed.  A net credit spread with a spread of 5 dollars between the strikes will use up $500 in margin per spread. 

BicycleB

  • Walrus Stache
  • *******
  • Posts: 5271
  • Location: Coolest Neighborhood on Earth, They Say
  • Older than the internet, but not wiser... yet
Re: Can we talk about puts?
« Reply #14 on: September 21, 2022, 03:16:10 PM »
(brain attempts to process)

Great discussion!

MustacheAndaHalf

  • Walrus Stache
  • *******
  • Posts: 6665
Re: Can we talk about puts?
« Reply #15 on: September 21, 2022, 06:16:09 PM »
In my journal I mentioned put options back on April 6.  I structured the investment like a "3 stage rocket" of SPY puts ($450 / $370 / $325).  If the market hits -25% down, I sell the first stage.  The profit from that pays for the entire rocket, but it's breakeven.  If we hit -35%, I have a profit.  Finally if things near -50%, I sell the last stage for a nice profit.  Since the SPY (S&P 500 ETF) hasn't dropped to $337.50/sh yet, I still hold all stages of put options.  In my view, this is a well planned strategy for approaching a bear market.

I see two problems with trying to imitate this strategy right now.  When I bought in early April, the $VIX (volatility index) was about $22, and now its $28.  Expected volatility raises the "time value" cost of put options.  Second, SPY has dropped 17% since I bought.  Combine the SPY drop and time value, and my $450 put options have increased in value 70%.  Someone imitating me would pay 170% of the price I paid.

I would advise greedy investors to avoid this approach.  Greed focuses on gains, but that makes losses extremely painful.  What's worse, humans weigh losses twice as heavily as gains.  A greedy investor's breaking point is far more likely to occur after a loss.  Recent experience isn't that helpful, either, since we've had a bull market from 2009-2021.  An investor could have 12 years of experience without ever seeing a big crash (like 2008, or dot-com).  In my view, most people shouldn't do it - but I hope there's a couple people with 15+ years investment experience who aren't very greedy that might find it interesting.

ChpBstrd

  • Walrus Stache
  • *******
  • Posts: 6751
  • Location: A poor and backward Southern state known as minimum wage country
Re: Can we talk about puts?
« Reply #16 on: September 22, 2022, 07:22:19 AM »
...Since buying long puts is essentially a gamble/timing the market, you could look at other options strategies too... 
Not necessarily...The approach I advocate, which is also the cheapest way to hedge against sequence of returns risk AFAIK, involves a plan to stay hedged for multiple years. Trades or changes done per the strategy are all based on information available at the time when the decisions are made.

Perhaps you mean the decision to hedge or not hedge at all is a gamble/timing decision, regardless of timeframe? As @MustacheAndaHalf points out, it is possible to regret the cost of one's hedges for an entire bull market decade.

However, for the 2009-2019 decade, one should have also regretted their bond or cash allocation. Anything less than 100% stocks was suboptimal during that period, and by comparison a 75/25 portfolio would have cost you a couple percent of return per year compared to an all-in approach. If we look beyond traditional stock/bond AA's, we might regret not putting 100% of our portfolio into California real estate and call options on Netflix. Ten years from now, we'll look back and regret not going all-in to something else.

Long-term hedging is a recognition that we do not know the future (as opposed to the gambler / timer, who claims to know the future). It is the act of positioning oneself as aggressively as possible to catch the upside of markets, while paying a tax to protect against SORR. It is the selection of a limited-upside, limited-downside returns function as one's AA.

dignam

  • Pencil Stache
  • ****
  • Posts: 627
  • Location: Badger State
Re: Can we talk about puts?
« Reply #17 on: September 22, 2022, 07:28:21 AM »
@ChpBstrd I suppose I'm thinking it's more of a gamble if you're buying very near expiration puts (like a week or two away).  I agree it's less of a gamble and more of a hedge depending on how it's set up.

ChpBstrd

  • Walrus Stache
  • *******
  • Posts: 6751
  • Location: A poor and backward Southern state known as minimum wage country
Re: Can we talk about puts?
« Reply #18 on: September 22, 2022, 07:29:52 AM »
@ChpBstrd I suppose I'm thinking it's more of a gamble if you're buying very near expiration puts (like a week or two away).  I agree it's less of a gamble and more of a hedge depending on how it's set up.
I'll agree with that!