Stocks & Commodities V. 30:2 (60): Explore Your Options by Tom Gentile

Explore Your Options by Tom Gentile

PUTTING IT TO BETTER USE

If I want to accumulate a stock over time and am willing to buy on weakness, is hedging shares with protective puts the best means to do this? Or would a short put strategy be a better approach?

That’s a wonderful question. In the first scenario, by buying or “marrying” a put in conjunction with shares, you as a trader have guaranteed yourself limited losses and guard the stock against a bearish downside catastrophe. As someone who also wishes to buy on such weakness, as long as your outlook on the stock hasn’t changed, the small resulting loss compared to the kind suffered by a bull simply holding shares will mean you’re in a stronger position to average in or accumulate on weakness and capitalize on attractive value for a longer-term commitment.

With a married put, the trader always maintains control of their maximum risk exposure while allowing for unlimited upside, and after factoring in the cost of the put. These benefits, of course, aren’t free, as the trader is paying for protection, which increases the cost basis of the stock position. This can prove expensive if the stock isn’t dropping strongly enough to make the put worthwhile. Worse yet is if multiple put purchases over the course of a few months prove unnecessary and thus add up to being expensive protection, or if shares simply aren’t rising enough in price to offset the cost of the put(s).