option and stop

Discussion in 'Trading' started by klin, Oct 3, 2001.

  1. klin

    klin

    I'm thinking of using option instead of stop to protect a position. Say if you bought XYZ @ 21, then you bought a 20 put option of XYZ at the same time. If market moves up, your profit will be offset by the premium, and when it moves down, the option functions like a stop.

    Is it doable? If so, what strike and time frame is of the best in terms of either protecting your lossing position or/and maxmizing your profit?
     
  2. vikana

    vikana Moderator

    I don't find it cost effective to use options as stop proxies during the day. However, to protect overnights it's a very good option. Consider QQQ options if you're protecting a portfolio.
     
  3. What you've synthetically constructed is a long call position.

    Long stock delta = +100 long put delta = -40. Net position is
    equivalent to +60 delta long call.

    If you want an absolute stop, save one commission by buying the atm or slightly otm call. If the stock takes off you'll be up money and if the stock tanks you only have premium at risk.

    Cheers
     
  4. I agree that it's a bit cumbersome for a daytrade, but if you're looking at a swing trade and can't watch your positions all the time, you might consider an options collar. In your example, you bought the stock at 21. To do a collar, first you sell a higher strike call, say at 25. Then you take the premium you receive from the call to purchase a protective put at 20.

    This strategy protects you on the downside if the stock goes below 20. The only thing about this is that your upside is limited to the stock going to 25, since you'll be called out if it goes above that. However, this strategy is a good one if you're looking for a safe play with a decent potential return, especially in this kind of market.