Does Buying Puts Actually Work?

My last post looked at buying puts for portfolio insurance. The question remains, does put buying for portfolio insurance actually work? To answer this conclusively one needs to do exhaustive research on multiple market declines and associated put option behavior. Here, we can look at one example which can give us a clue to answer the larger question.

Let's consider an idealized example from last year. Suppose last year at this time, you owned 100 shares of the SPY on April 23, 2018 and you bought the at-the-money put for put insurance.

4/23/2018 SPY closing price: $266.56; SPY at-the-money 12/31/2018 266 put: $12.315 = 4.1906% of SPY share price.

12/31/2018  SPY closing price: $249.92.

Thus at year end, your put expired at an idealized value of $16.08 (266-249.92, assuming a perfect exercise and cover of the short stock position at $266).

How did the portfolio insurance work out? With NO insurance your SPY position lost $16.64 (excluding dividends) or 6.2425%. WITH insurance, you lost 56 cents (-16.64+16.08) or .21% of your capital. There is no coincidence that the loss equals the 56c difference between the stock and the strike price.

Feel free to post comments.

Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.

New S&P Highs and the Cost of Insurance

This past Friday, 4/26/2019, the S&P 500 stock index, SPX, closed shy of a new high at 2939.88, marking a year-to-date gain of 17.27% from its 2506.85 close at 2018's year-end.

Much is written about the whys and wherefores of this new high. Little has been written about the cost of portfolio insurance. One sensible way to hold your current positions and still protect yourself from a market decline is to buy a put option-one of the least expensive forms of portfolio insurance.

If, like many of us, your investment portfolio consists of an S&P index fund or similar holding, you have an excellent choice of ETFs to choose from: SPY, IVV, VOO and more. Put options are readily available. 

The SPY is the world's largest ETF and SPY options may be the most liquid and lowest cost. Suppose we own 100 shares of SPY which closed 4/26/19 at $293.41 per share and we wanted to "insure" our portfolio at this market high for the rest of the year.

Which put option should we buy? Short answer is the end of year "quarterly" 12/31/2019 "at-the-money" 293 puts which closed at $12.29 (as marked by my broker) or 4.188% of the SPY closing price. Basically between now and the year end, the most you could lose on your SPY position is the 4.19% paid for the insurance. Gains, of course, would be 4.19% lower than if you didn't have the insurance. 

The above charts the gains and losses of this example. The green line is the gain and loss of the entire portfolio of SPY at 293.41 and the Dec 31 293 put. Let's parse this in insurance terms:

The coverage is 100 Shares of SPY at $293.41 per share;
The the term is time until expiration;
The payout is the $293 per share strike price*;
The "deductible" is the difference between the $293.41 closing price and the $293 strike price or 41c per share.

The put will pay you dollar for dollar if the SPY closes below 293 on expiration*. Anytime before expiration is less certain. Put prices can vary widely in the interim depending on the moves on the underlying. Of course, if SPY expires ABOVE 293, you don't have a loss and your insurance expires.

*The actual payout may require you to sell exercised stock and there's many more considerations with portfolio insurance including dividends, margin and commissions. Contact me for more information.

Feel free to post comments.

Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.

Stock vs Options Example

MSFT closed at $123.37 on the Easter holiday shortened weekend 4/18/19 close.

Suppose you bought 100 shares for $100 a share on 1/4/2019 and sold them on 4/18/19, a perfect trade indeed.

buy at $100
sell at $123.37
profit = $23.37 per share!

Now here are three MSFT options trades as of 1/4/2019 that expire on April 18, 2019:

The out-of-the-money $110 call:

buy at $3.35
sell at $13.37
profit=$10.02
or, you need 2.3 calls costing a total of $7.70 to equal the same profit as the stock.

The at-the-money $100 call:

buy at $7.925
sell at $23.37
profit = $15.425
or you need 1.51 calls for $11.96 to equal the same profit

and finally, the in-the money $90 call:

buy at $14.75
sell at $33.37
profit = $18.62
or you need 1.25 calls for $18.43 to equal the same profit.

Now this assumes perfect timing, perfect pricing and perfect quantities which of course doesn't happen. If you sold earlier your gains would be less. If you held on, your options would expire at the current stock price. Either way, you cannot buy option fractions, so there.

The problem with options for portfolio maximizers is that for a given stock move options leave money on the table. The problems are both the options delta and the extrinsic/time value or "juice". Option buyers must overcome the small participation from low deltas AND must burn off all of the extrinsic value before receiving any of the stock's gain.

If you want a high delta, the .78 delta 90 calls have huge $2.82 juice. Low juice $120 calls cost $1.095, all extrinsic value.

In theory if you are good enough you can get the same move as the stock but you need guesswork. Spend $10.05 for three 110 calls, $15.85 for two $100 calls or $29.50 for two $90 calls will get you your $23.37. All of the above beat the $100 spend for a share of MSFT.

Feel free to post comments.

Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.

First Post of a Reinstated Blog

This is my first post for my reinstated blog. I will be entering years of posts on investments and commodities in the archive but I have to figure out how first. Feel free to comment anytime.