Professional Options Trading Course

Lesson 5: Hedging a Portfolio

with Protective Puts

Adam Khoo Bang Pham Van

Professional Trader Options Trader & Specialist

www.piranhaprofits.com
www.wealthacademyglobal.com
 Strategy 4: Protective Puts
Purpose:
• To Protect Unrealised Profits on a Long Stock Position, whilst allowing
the Potential for Future Gains if the Share Price Continues to Rise
• Not to Generate Profits But to Protect Unrealized Profits

Strategy:
• You initially bought 100 shares of SAVE stock at $45. Cost = $45 x 100 = $4,500
• 4 Months Later, SAVE is now at $65. You Have Unrealized profits of ($65 - $45) x 100 = $2,000
• You anticipate a potential price correction. You could sell the shares to lock in the profit but this
prevents you from benefiting from future increases in the stock’s price
• You buy a Put Option (Strike Price $65, 60 Days to expiration).
• You now have the RIGHT to SELL the stock at $65 in the next 60 days. This locks in your gains.
• You pay a premium of $4.00 x 100 = $400 for this insurance.
 Strategy 4: Protective Puts

Buy 1 Contract SAVE

$65 Feb 65 Puts at $4.00

Cost = $400
Unrealized profits
($65-$45) x $100 = $2,000

Buy 100 shares x $45 = $4,500

Price Falls Back to $45 in 60 Days Price Rises to $85 in 60 Days

Unrealized Profits = ($45-$45) x 100 = $0 Unrealized Profits = ($85-$45) x 100 = $4,000

Profit from Put Option
= Strike Price - Stock Price - Premium
= $65- $45 - $4.00 = $16.00 per share
Total Profits = $16.00 x 100 = $1,600
Max Loss from Put Option (Expires worthless in 60 days)
= $400
Net Profits = $4,000- $400= $3,600
Buy 1 Contract SAVE April 85 Puts at $5.50
 Strategy 4: Protective Puts
• SAVE Stock at $65
• Buy 1 Contract SAVE Feb 65 Puts at $4.00
Long stock
Profit Protective Put

Stock Price
$65 $69
Breakeven Point
-$400

Loss • Maximum loss = Premium Paid = $400

• Breakeven point = Strike Price + Premium =$65 + $4 = $69
• Unlimited Potential Profit
 Case Study: Protective Puts
• You Bought 100 shares of KL at $20. Initial Investment = $2000
• Current Price is $30.32. Current Value is $30.32 x 100 shares = $3,320
• You want to lock in your unrealised profits of $1,320
• You Decide to buy 1 Contract KL Apr 30 Puts (60 days to expiration) at $2.13

Current Price $30.32

Initial Cost $20

 Case Study: Protective Puts
1. How much does it cost to buy 1 contract of KL April 30 Puts?
- Total premium is _________________________
2. What will happen if the KL stock price declines to $20 in 60 Days?
- Net Profit From the Trade is $ ___________________________________
3. What will happen if the KL stock price Increases to $40 in 60 Days?
- Net Profit From the Trade is $ ___________________________________
4. Draw the Risk to Return Graph showing the maximum risk, breakeven at expiration and Maximum Profit

Profit Long stock Protective Put

Stock Price
$__ $___
Breakeven Point
-$____

• Maximum loss = Premium Paid = ______

Loss • Breakeven point = Strike Price + Premium =_________
• Unlimited Potential Profit
 Hedging a Portfolio
with Protective Puts
Purpose:
• To Generate Short Term Profits to Make Up For Unrealised Losses in Your Long Term
Investment Portfolio during a Bear Market

Strategy:
• You hold a portfolio of stocks which you are invested in for the long-term
• Although you are confident that the shares will increase in value in the long term, you
expect prices may fall 20%-40% in the short term because of a bear market
• Instead of selling your shares and incurring capital gains tax and transaction costs, you
decide to buy Put Options to insure the current value of your investment portfolio
• If the market price of your shares do fall in the short term, the Profits generated from
The Put Options Contract would hedge or offset the temporary, unrealised losses in
your investment portfolio
• If the market does not decline as anticipated, the Option premium would be the ‘cost’
of protecting your portfolio. Similar to buying Fire insurance on your house.
 Stock Market Cycles
Bull markets (5-15 Years)
90% of the Time
Higher highs and higher lows- prices go higher
Economic growth and optimism

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s) Bear markets (6 months -2 years)
10% of the Time
Lower highs and lower lows- prices go lower
Recession and Pessimism
Bear Markets

Bear Market Avg Decline

-29% without recession
-42% with recession

9
 Bear Markets
• In a Bear market, Majority of stocks would decline in price depending on their ‘Correlation’ to the
S&P 500
• Bear Market in the Index (e.g. S&P 500) is signalled by 50MA crossing below 150MA (with
both MA flat or sloping down) OR Index below 200MA (200MA sloping down)
• We can buy ‘Put Options’ on the SPX (S&P 500 Index) or the SPY (S&P 500 ETF) to hedge
against our Portfolio of Various Stocks

Bear Market: 6 months -2 years

Beta: Correlation Between a Stock & S&P 500
• A Stock’s ‘Beta’ is a Measure of How Volatile a Stock is Compared to the Index (S&P 500)
• If a Stock has a Beta of 1, it is 100% correlated to the S&P 500
• MNST has a Beta of 1.52 : 1% move in the S&P 500 Leads to a 1.52% move in MNST
• To Hedge $1,000 Worth of of MNST Shares, you would Buy Puts on $1,500 worth of
SPY shares
• AVGO has a Beta of 0.74: 1% move in the S&P 500 Leads to a 0.74% move in AVGO
• To Hedge $1,000 Shares of AVGO, you would Buy Puts on $700 worth of SPY shares
How to Hedge a Portfolio with SPY Put Options

Stock Market Value Stock Beta Beta Weight Value

MCD $15,000 0.57 $8,550
AMZN $10,000 1.63 $16,300
MSFT $10,000 1.24 $12,400
FB $10,000 0.75 $7,500
BA $12,000 1.23 $14,760
BLK $10,000 1.43 $14,300
JPM $10,000 1.13 $11,300
YUM $10,000 0.61 $6,100
SPY $20,000 1.0 $20,000
GXC $10,000 1.72 $17,200
TOTAL $117,000 $128,410
How to Hedge a Portfolio with SPY Put Options
• 1) Calculate the Beta Weighted Value of Your Portfolio
• For each stock, Multiply the Market Value by Beta
• Total up the Beta Weighted Value of the Portfolio (e.g. $128,410)

• 2) Calculate the Number of SPY Contracts Required

• Divide Beta Weighted Value of Portfolio by SPY Share Price
• Weighted Value of Portfolio = $128,410
• Current SPY share price = $270
• Number of SPY shares = $128,410/ $270 = 475 shares = 5 Contracts of SPY Puts

• 3) Choose the Expiry Date and Strike Price

• Choose the Expiry Date Based on How Long You Want to Hedge Your Portfolio (At least 90 days)
• Choose the Strike Price (I Prefer ATM with Delta 0.5 to 0.6)

• 4) Place a Buy Limit Order for the SPY Put Contracts

• 5) Roll the Protective Put Contracts 30 Days to Expiration if Necessary

• If the S&P 500 Index Downtrend Continues (20EMA below 40EMA)…
• “Sell to Close” the Long Put Contracts 30 Days to Expiration
• “Buy to Open” New Long Put Contracts with New Strike Price and New date to Expiration
• If the S&P 500 Starts Reversing into an Uptrend (20EMA above 40EMA)
• “Sell to Close” the Long Put Contracts 30 Days to Expiration
 Protective Put Advantages and Risks
• Advantages:
• Allows you to hold onto your stock and participate in the upside potential
whilst insuring against any losses in the short term
• The cost of buying insurance (i.e. premium) is low, considering the sum
insured
• Maximum loss is the premium paid

• Risks:
• Cost of the Put Option (i.e Premium) eats into your profit
• Put Option Loses Value As Time Passes (Time Decay)
• The option has a limited time to expiry and must be renewed for
protection to continue
Professional Options Trading Course
Lesson 5: Hedging a Portfolio
with Protective Puts

Adam Khoo Bang Pham Van

Professional Trader Options Trader & Specialist

www.piranhaprofits.com
www.wealthacademyglobal.com