Trading Tip #9: HEDGING WITH OPTIONS

Skill Level: Basic to Intermediate.

Before mom and pop had even heard of Options (Calls/Puts), the big guys .aka. Institutional Investors had been using options for many years to hedge their massive uberly leveraged positions. In fact, the main purpose of Options is HEDGING. It was not until recent times, just like every other financial instrument out there, that Options transitioned form an Hedging Instrument to a Speculative Instrument, that the Hot Dog Guy @ Times Square can use to gamble his retirement savings on NFLX Call Options. I mean seriously, these greedy Wall Street Fu*ks wont stop at anything; they always find a way to make money out of thin air. There’s even talk these days that they’re planning to issue a new breed of financial instruments that will allow mom and pop to bet of complex derivatives like CDS, MBS, ABS, etc… The ultimate FML moment. Jokes apart, in this post, I’ll be discussing a very easy and simple hedging strategy, that any noob out there can use to hedge their positions against market volatility. Now keep in mind, there are a million ways you can use options as a hedging instrument; I’d have to write a book to cover all those strategies. Instead, lets start small, and then in the future, we can do some advanced stuff.

If you haven’t noticed already, the market is at an all-time high. If you’re not careful, you will get burned. Hence, amidst all the BTFD hysteria, the big guys are hedging their positions, just in case shit gets real. In this post, I’ll be discussing Writing Covered Calls and Covered Puts. Here we go:

Covered Calls:

Lets assume you’re long 100 shares of XYZ stock @ $100, with a price target of $105. If you are one of those, “I shit my pants every time I look at my P/L” kinda guy/gal, what you can do is, you can Write (SELL) a $105 XYZ Call which is currently selling for $5; That way, if the stock goes $105+, you’ll make your original target of $5 + $5 call premium, and take your loved ones out for a dinner @ Olive Garden; if the stock goes <100, your break-even price will be $95. Everyone Wins.

Capital Gain + Call Premium = Total Profit

Total Profit: $10

Covered Puts:

For Puts, it’s just the opposite. Lets assume you’re Short 100 shares of XYZ stock @ $100, with a price target of $95. You can Write (SELL) a $95 Put which is currently selling for $5, and if the stock goes <95, you make your original target of $5 + $5 put premium; if the trade goes against you, you’re Break-Even will be $105.

Capital Gain + Call Premium = Total Profit

Total Profit: $10

Since I’m not an Academic or a Professor, that’s the best I can do when it comes to explaining what’s in my head. If you’re confused or have any questions, go to your local church and surrender yourself to Jesus.

Stay tuned for the next trading tip.

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