Hedging trades with weekly options?

lazy_eyed_ladykiller

Junior member
11 1
I could not find the right forum to put it as I am not sure whether this is a stock or options question. I have am getting a bit tired of getting stopped out early, only for the stock to go as planned, so I came up with this idea. It is for weekly swing trades, or even longer time span.

Say you want to go long on a stock, ABC, and it's currently at $50. You trust your gut, check the charts, check the technical analysis and fundamental analysis and you decide to go long at 50$. This is a very liquid stock and you feel that strong market momentum is coming within the next 2-3 days, but you are worried about the off chance you may be wrong. You don't want a panic sell if it moves down, and you want to give it a few days to run.

So you go long at 50$, 100 shares, and buy a weekly 50$ put for say a 1$, ATM to hedge your position.

Yes this is a protective put that we are all familiar with you, but you are using the weekly because you WANT that time decay to make it as cheap as possible as you think a move is coming in a week as opposed to a month or 3 months. Remember you just need it a few days in the initial trade. Just like a rocket dumps those fuel canisters once it's out of the atmosphere, you just need the option in this case to protect you for a little while.

So after you have purchased this option all you need would be 1$ move up in your direction in order to pay off this insurance policy, and prior to that your loss for the week is completely capped at 1$ per share or 100$ total (plus a bit for options commissions).

For this 1$ you've basically bought peace of mind, and have entirely eliminated that thought of getting stopped out too early, only for the trade to go as plan. This cheap option will always be there protecting you until Friday.

Step 2:

After the stock has made a favorable move up of 1-2$, you stop loss yourself there to ensure the option's premium is now covered. Should you get stopped out, you have now ensured the option is paid for and as the stock head back towards the option, you can sell off the option as it rises back in value to pocket the entire price of the option as a gain. If the stock moves past your initial entry point after getting stopped out on the stock, your option has grown and you get to keep not just the entire premium, but the gains that the option is making now.


At this point you can chose to cash in on the option and exit the trade or go long again on your stock, with absolutely zero risk as the option has now been totally paid off, and any gains from the stock at this point for the next few days are pure profits.

If of course the stock continues to move past the price of your option premium, then this is perfect as you can trail it now with a stop for all the gains that are higher than your initial option price.

3. If you are slightly more unsure about the stock's direction, you can even add one more weekly option, this time slightly OTM. You just have to make sure the stock moves enough to cover the costs of these options so you can cap even more of a return on the option premiums when you resell them should you get stopped out on the way back down.

4. Of course if you are shorting, you would take an entirely opposite approach and use call options as opposed to weekly puts.


5. If the stock hits your stop loss at the option premium, and continues in the direction as planned, you can rebuy, and limit your losses to the price of the stock - option strike (and since the option is very cheap, your loss would be super cheap as well), or just sell the option and get the gain.

So in summation, all you would need to make a profit would be for the stock to cover the cost of your option(s) premiums over the course of a week. And since weeklys are so dirt cheap, especially after an earnings report or announcement, you just need a small movement to cover their costs.
Your entire loss would be limited to the option premium, and you would not have to worry about setting a tight stop loss only for the stock to move in your favor, as the options are acting as a tight stop loss without that consequence.

Feed back is welcome. Thank you.
 

ACstudio

Active member
138 14
Statistically over time this is a losing strategy. Better to sell a covered call at more duration which directionally is the same as selling a put. The prob lies directly in your statement that all the stock needs to do is rise enough to cover the cost of the put. When you buy a stock your breakeven is the purchase price. When you buy stock and put your break even is the purchase prices combined. If you buy a stock and sell a call your break even is the purchase price MINUS the credit received. Much better odds. If you are very bullish and need less protection just go further out of the money or under hedge by selling fewer calls than 100 lots of stock. Or go further out in time. Lots u can do.
 

lazy_eyed_ladykiller

Junior member
11 1
Correct me if I'm wrong, but is a covered call not a overall bearish strategy? In my strategy, you would want the stock to go up if you're long, and down if you're short (in which case I suppose in your strategy, you'd use a covered put). You're just using the options as protection. Basically, this is an equities focused strategy with a potential for unlimited gains with limited losses.

Secondly, can you explain to me what difference is there between my statement that the stock just needs to move enough to cover the price of the option vs, yours, " When you buy a stock your breakeven is the purchase price. When you buy stock and put your break even is the purchase prices combined." If I buy a stock at 50$ and long a put for 1$, my break even would be 51.00$, or I would need the stock to rise by 1$ and everything after that is pure profit, no? Even if the stock rises to 51.01$ and comes back down, after I have covered that initial premium of the option, I can always sell off the option to make a full gain on the price. And if the option moves favorably past its strike, than it's even better for me.

A super liquid stock, say, GPRO where swings of 1-3 dollars a day are common. Would a week time frame for the stock to rise to or above /fall to or below the price of the put/call, not be adequate?

Thanks for the input!
 

lazy_eyed_ladykiller

Junior member
11 1
Ok after referencing the options manual, I see what you're saying. In essence with a CC my cost basis of the stock will be reduced by the premium of the call, with my gains capped, and no downside protection past stock price - call premium from my sale. With a protective put, my cost basis is increased, with my gains uncapped and complete downside protection.

They're both yin and yang, and I guess it's all a matter of preference. I can't see why a PP would statistically be more of a losing position than a CC in that sense.
 

ACstudio

Active member
138 14
Ok after referencing the options manual, I see what you're saying. In essence with a CC my cost basis of the stock will be reduced by the premium of the call, with my gains capped, and no downside protection past stock price - call premium from my sale. With a protective put, my cost basis is increased, with my gains uncapped and complete downside protection.

They're both yin and yang, and I guess it's all a matter of preference. I can't see why a PP would statistically be more of a losing position than a CC in that sense.


A covered call is a bullish strategy. If you buy a stock you have 1 delta. If you sell a call against it at .40 deltas you are still synthetically long 60 shares of stock.

So...if you buy a stock your probability of profit is 50%. If you buy a stock at 50 and buy a 1st out of the money put for a dollar now you need it to go to 51....means your probability of profit is about 35%. If you buy a covered stock by selling a 1st out of the money call for 1$ then your probability of profit is around 65%. Because the stock can go up, sideways or even down by .99 and you still are profitable. When you buy a put you lose money of the stock goes down less than .99 or sideways or only up by .99. It's not ying/yang. It's just the math of it. The only way to increase your probability of profit is by limiting your upside and letting the other guy take the long shot at unlimited upside while you grind out consistent gains.....and the good news is that there are plenty of those people out there.

And with covered calls you can keep rolling them to further reduce you break even point...for ever. You can roll them down in the same month if you have a big down move or you can roll them out for more duration and credit. If you buy a put all you do is add to your risk profile every time you buy one.

Also the short call will gain in extrinsic value for you as time moves forward...where the long put will lose extrinsic value as time moves forward. And one thing is for sure...no matter what the price does...time will go forward...every time.

Also a 1st out of the money put might have -40 deltas....so you buy it....so now you are at net 60 deltas of risk per 100 lot. Even if the stock moves down it has to move down to the strike price plus the amount you paid before the protection begins to add up. So maybe by that time it absorbs e few deltas of risk....but that put will have to be deep in the money before it starts to offer 1/1 protection against further downside...al the time losing extrinsic value.



I know it may sound like a good idea at first but the math just doesn't work out in the long run...or even the short for that matter.
 
 
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