37 lines
2.0 KiB
Plaintext
37 lines
2.0 KiB
Plaintext
250 • The Intelligent Option Investor
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The graphic conventions are a little different, but both diagrams show
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the acceptance of a narrow band of downside exposure offset by a bound-
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less gain of upside exposure. The area below the protective put’s strike price
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shows that economic exposure has been neutralized, and the area below
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the ITM call shows no economic exposure. The pictures are slightly differ-
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ent, but the economic impact is the same.
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The objective of a protective put is obvious—allow yourself the
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economic benefits from gaining upside exposure while shielding yourself
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from the economic harm of accepting downside exposure. The problem is
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that this protection comes at a price. I will provide more infromation about
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this in the next section.
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Execution
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Everyone understands the concept of protective puts—it’s just like the
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home insurance you buy every year to insure your property against dam-
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age. If you buy an OTM protective put (let’s say one struck at 90 percent of
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the current market price of the stock), the exposed amount from the stock
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price down to the put strike can be thought of as your “deductible” on your
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home insurance policy. The premium you pay for your put option can be
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thought of as the “premium” you pay on your home insurance policy.
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Okay—let’s go shopping for stock insurance. Apple (AAPL) is trad-
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ing for $452.53 today, so I’ll price both ATM and OTM put insurance for
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these shares with an expiration of 261 days in the future. I’ll also annualize
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that rate.
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Strike ($) “Deductible” ($) “Premium” ($)
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Premium as
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Percent of
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Stock Price
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Annualized
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Premium (%)
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450 2.53 40.95 9.1 12.9
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405 47.53 20.70 4.6 6.5
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360 92.53 8.80 1.9 2.7
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Now, given these rates and assuming that you are insuring a $500,000
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house, the following table shows what equivalent deductibles, annual
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premiums, and total liability to a home owner would be for deductibles
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equivalent to the strike prices I’ve picked for Apple: |