Investment strategies – Guide to option strategies

Stock market eletronic board

Protective Put

With a Protective Put one acquires the underlying and a put option. The purpose is to insure the put option in case prices fall. Therefore, it is considered an important means to implement portfolio insurance.

The difference between the protective put and covered call is that the protective put secures a minimum selling price, and it pays a premium and a maximum sale price, while a covered call and receives a discount .

An investor employs the protective put strategy when he has unrealized gains from the appreciation of the underlying assets and there are concerns about future prices and wants to hedge against a negative performance of the underlying. The protective put strategy is a bullish option strategy.

Regardless of how much losses are experienced on the underlying during the term of the put in value, the put warrants gives the investor the right to sell his shares at the strike price of the put option until the option expires.

The put option not only guaranteed the investor the sale price at the strike price, but gives him control over  time of the sale of the underlying security during the term of the option itself.

Reverse hedge

In a reverse hedge the underlying is not acquired, but rather sold short, hence, the name reverse, and calls to either long or short puts are used. The reverse hedge strategy is sometimes referred to as simulated straddle. Ideally, the underlying sold short Underlying this strategy is very volatile.

Very volatile underlying assets such as volatile stocks, have the advantage that the short seller does not have to additionally pay the dividend to the buyer. Company with a highly volatile stock price to pay significantly less dividend to its shareholders.

With a net reverse hedge with short puts one speculates on steady to slightly declining stock prices.

Collar

A collar is a combination of the purchase of a put and selling a call option to hedge an existing stock position. Expenses for the purchase of the put option can be reduced (with a higher strike price) by the simultaneous sale of a call option.

If the cost of buying the put option and the proceeds from the sale of the call option is offset exactly, it is called a zero-cost collar.

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