I’ve done a series articles in which I described the use of put options as a protection against losses on holdings of stocks or exchange-traded funds.
-
Using Puts vs Stop-loss Orders to Protect Stock Positions – Part 2
-
Using Puts vs Stop-loss Orders to Protect Stock Positions – Final Thoughts
Today, we’ll do one last update on this theme to show that the option trading strategy worked as planned.
In the original article I used the example of a 100-share position in SPY, the exchange-traded fund that tracks the S&P 500. At that writing on September 11, 2018, SPY was at $289.33 per share. The put that we looked at as protection was one at the $265 strike that was due to expire six months later, in March 2019. In September that put was priced at $4.91 per share. The 265 strike was chosen so that an arbitrary 10% loss was the worst case scenario if SPY went down.
In the update in January 2019, we noted that by December 24, 2018 SPY had indeed melted down from $289 to $234, a drop of $65 per share or almost 19%, the worst fourth quarter for the stock market since the Great Depression.
This was a great stress test for our $265 protective puts. We showed that the puts that we had selected three months earlier to limit our loss to no more than 10% of that $289 original price, had done exactly that. Rather than the full 19% that SPY had dropped, our loss to that point would have been exactly 10%, if we had liquidated. That was all we could possibly lose no matter how much further SPY dropped, even to zero. Our put options were now earning a full dollar per share for every additional dollar that SPY dropped, completely canceling out any further losses, no matter what.
At this point in December 2018, the March 2019 put options that we held still had three months until they expired. There was no need to liquidate the SPY position before March, since the loss could not possibly increase so we were free to hold it and the puts until March. It was possible that SPY might recover somewhat, and our loss might even be less than the 10% worst-case result we now had.
Fast-forward to the expiration date of the puts – March 15, 2019. After a huge rally in January, February and March, SPY had climbed from $234 back up to $281, just $8 or 1.7% below our $289 starting price. We still owned the SPY shares and could still participate in any further upside moves. If we wanted to, we could buy more insurance to replace the expired policy.
Here’s what the SPY chart looked like at that time:
In the end, spending the $5 or so per share for the insurance had allowed us to weather a hair-raising $65 / 19% drop without flinching and hang in until the SPY had almost completely recovered. This resulted in an end result of just about a 4% haircut, including the cost of the insurance – and, we still own the SPY.
In this five-part series, we’ve pretty thoroughly covered how put options work from the point of view of the put buyer, who is purchasing insurance. In the future, we’ll look at it from the point of view of the put seller, who acts like an insurance company. As we’ll see, selling insurance is a pretty profitable business too.
Read the original article here - Puts for Protection – Update
This content is intended to provide educational information only. This information should not be construed as individual or customized legal, tax, financial or investment services. As each individual's situation is unique, a qualified professional should be consulted before making legal, tax, financial and investment decisions. The educational information provided in this article does not comprise any course or a part of any course that may be used as an educational credit for any certification purpose and will not prepare any User to be accredited for any licenses in any industry and will not prepare any User to get a job. Reproduced by permission from OTAcademy.com click here for Terms of Use: https://www.otacademy.com/about/terms
Editors’ Picks

AUD/USD keeps range near 0.6350, Fed Minutes eyed
AUD/USD trades in a range around mid-0.6300s early Wednesday. The cautious market mood, the RBNZ dovish rate cut and Trump's tariff threat-led US Dollar upside remain a drag on the Aussie. Focus shifts to the Fed Minutes amid trade war fears.

USD/JPY stays pressured below 152.00 amid cautious markets
USD/JPY keeps its offered tone intact below 152.00 in late Asian trading on Wednesday. US President Trump's latest tariff threat and BoJ rate hike expectations underpin the Japanese Yen amid a pause in the US Dollar rebound. Traders await the Fed Minutes for fresh trading incentives.

Gold price trades with mild negative bias; holds above $2,900 ahead of FOMC minutes
Gold price drifts lower as bulls opt to lighten their bets ahead of the FOMC minutes release. Concerns about Trump’s tariff plans and trade war fears lend support to the commodity. Fed rate cut bets undermine the USD and further act as a tailwind for the XAU/USD pair.

UK CPI set to rise in January, raising uncertainty over BoE rate cuts
United Kingdom’s Office for National Statistics will publish the January CPI data on Wednesday. The annual UK headline and core CPI inflation are expected to increase in January. The Pound Sterling braces for volatility on the UK CPI report data release amid a prudent BoE.

Rates down under
Today all Australian eyes were on the Reserve Bank of Australia, and rates were cut as expected. RBA Michele Bullock said higher interest rates had been working as expected, slowing economic activity and curbing inflation, but warned that Tuesday’s first rate cut since 2020 was not the start of a series of reductions.
RECOMMENDED LESSONS
Making money in forex is easy if you know how the bankers trade!
Discover how to make money in forex is easy if you know how the bankers trade!
5 Forex News Events You Need To Know
In the fast moving world of currency markets, it is extremely important for new traders to know the list of important forex news...
Top 10 Chart Patterns Every Trader Should Know
Chart patterns are one of the most effective trading tools for a trader. They are pure price-action, and form on the basis of underlying buying and...
7 Ways to Avoid Forex Scams
The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?
What Are the 10 Fatal Mistakes Traders Make
Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.

The Best Brokers of the Year
SPONSORED Explore top-quality choices worldwide and locally. Compare key features like spreads, leverage, and platforms. Find the right broker for your needs, whether trading CFDs, Forex pairs like EUR/USD, or commodities like Gold.