Market Crash + Puts = ?

Discussion in 'Options' started by tj1320, Nov 27, 2006.

  1. tj1320

    tj1320

    I have a question about market crashes and how it affects options. My mother brought this up to me because she is worried that I'll lose my money if the market crashed like it did in '29 and '87. I told her that if I had puts that I would profit greatly from a market crash and she doesn't believe me. I don't understand her way of thinking but is there any reason puts wouldn't be highly profitable if the market crashed again?

    I had calls prior to 9/11 otherwise I would have profited handsomely, based on the price movements I saw in the puts. I can't remember which stock it was now but I had some calls I purchased at around $4, give or take, and they went to around $.50 in the blink of an eye. I noticed that the puts had doubled, tripled, and even quadrupled VERY quickly. That said, how can a crash be bad for bearish positions?
     
  2. yes, the gist of it is you are correct. you can buy puts for DIA, SPY, etc.. to cover the indexes instead of specific stocks.

    But obviously, take into account they could expire worthless if the underlying stock doesn't move much or moves up. It all depends on how far out you're buying your puts.
     
  3. Well if we had a true market crash, than logistically nothing would really matter in terms of timing, premium, etc. for the puts. So yes you would gain thousands of percentage points on any puts.

    I will give you an example. The 1st trading day of 2000, QCOM was trading at $800ish. So lets say you wanted to protect your position with a LEAP or longer term put for insurance. Because QCOM literally tanked so much by several hundred dollars or more in that time frame, the puts appreciated thousands and thousands of percentage points.

    However hindsight is always easy. The problem you will face going forward, is how far out do you want to be insured, or are you really speculating and hoping to profit outright. With that said, timing is everything because if you buy the puts too soon or not at the right strike with the underlying not moving far or fast enough, you will have issues.

    Also on a day like today, puts will be fetching a huge premium.
     
  4. Which are perfect for naked positions :D
     
  5. I ALMOST bought some way OTM puts on OEX a day or two before the 1987 crash. I was thinking of buying the first ones for 1/16 down the list. I could have made 100's of times profit (don't recall exactly, but I think they were listed in the 30's or 40's). My broker talked me out of it since "the market has finished with the correction and is poised to move higher".
     
  6. tj1320

    tj1320

    Thanks guys, that is what I needed to know. She was worried that if the market crashed I would lose everything because there would not be anyone to sell to. The way I see it, if I purchased puts on stock XYZ for $3 and the market crashed along with the stock and the put was then trading at $10 x $10.50, I would have more than tripled my money.
     
  7. vetten

    vetten

    hello guys,

    what would you guys do RIGHT NOW to hedge a portfolio of $ 500,000 in the cheapest way possible year in year out?

    what would the cost be in a percentage of the trading capital?

    sorry guys, I dont know anything about options.:cool:
     
  8. Simple question, tough to give a simple answer, particularly to a newbie :->)

    Selling OTM covered calls provides a small hedge. You have to be willing to sell the stock and you maintain most of the risk.

    Buying protective puts does a much better job but they cost. The better the insurance coverage you want, the mgreater the outlay. If the stocks go nowhere, the puts lose 100%.

    Collars are a combination of both of the above. You sell OTM calls and use the proceeds to fund the cost of the puts. This establishes a profit ceiling and a loss floor. You can use a correlated index for overall protection or just hedge individual stocks on a risk basis (low/no need to hedge low beta stocks)
     
  9. vetten

    vetten

    thanks spin for your quick reply

    So just a quick scenario:
    so I dont sell my stocks, I buy puts on an index to have a 100% cover of my trading capital of $500,000
    I`m prepared to lose 100% of my puts purchase price (afer all its just like a house insurance premium)
    what would you suggest I buy and how much would it cost per year? (dont have to be exact)

    sorry if I`m asking too much

    thank you:cool:
     
  10. MTE

    MTE

    If your portfolio is fairly diversified then you could buy Mar 08 1450 puts for about 55.00. Let's suppose that the beta of your portfolio with respect to SPX is 1.2. So the adjusted value is $500,000*1.2=$600,000. The value of 1 SPX contract is 1450*100=145,000. So, 600,000/145,000=4.14 or 4 contracts. Therefore, in order to hedge your portfolio you would buy 4 SPX Mar 08 1450 puts at 55.00. The cost is 22,000 (55*100*4), which is 4.4% of your portfolio.

    If the beta of your portfolio is 1 then you'd need 3.44 contracts, but since you can only buy whole contracts you'd have to round it down to 3 or you could add some XSP puts (XSP is the mini-SPX, i.e. 1/10th the size of the SPX) to fine tune the number of contracts. So, you could buy 3 SPX and 4 XSP puts. The cost would be 18.700 or 3.74% (3*55*100=16,500 plus 4*100*5.5=2,200).

    One note of caution, the above mentioned put is ATM so, it will provide a FULL hedge ONLY AT EXPIRY in Mar 2008, you will be hedged from current level though as the put strike is 1450, which is where the SPX is, so for every point that the SPX is below 1450 in Mar 2008 you get 1 point. If you were to buy those puts and the market sells off next week then you won't be fully hedged as the current delta of the put is only 0.34 so for every 1 point move in the SPX the put moves 0.34. Obviously, as the put moves further ITM and closer to expiration the delta and thus the hedging effect increases.

    EDIT: In other words, if the market sells off 100 points next week and you decide to cash in the hedge, you'll get only about 45 points in profit on those puts.

    If the market is 100 points down next March then you'll get the full 100 points in profit.
     
    #10     Apr 13, 2007