Strategy: Buy n ATM Puts, Expire ≤ 56 DTE
Buy or Own n × 100 Shares
Example:
Price Chart: Uptrending
Current IV%: ≤ 20%
IV Rank: ≤ 30
Trade: Buy n ATM put option contracts for each 100 shares of stock owned or bought.
Typical Strike Delta:
ATM Long Puts ≈ −0.50 to −0.45
Goals: Traders commonly buy or own stock when they believe the stock price will increase in value. The puts are bought to hedge an unexpected drop in the price of the owned stock. Recall from an earlier discussion, there is no such thing as a perfect hedge. A hedge offsets a portion of a potential loss. As with the synthetic long put options, the 0.50 Delta value of the ATM long calls is one-half the Delta 1.0 value of the stock. The trader expects the price of the stock to rally, as shown on the risk profile.
Manage: When the long stock rallies in value by several dollars per share, the trader may decide to sell it for profit and sell the long puts for the remaining premium. The trader may also consider keeping the stock for use with a series of covered calls. If the price of the stock begins to drop, the trader may decide to sell the stock. A price drop moves the strike of the long puts ITM for an increase in premium value. This offsets roughly half the loss in stock value. If the stock is sold, and the price continues to drop, the long puts may offset a substantial percentage of the loss in stock value. As soon as the premium of the long puts either plateaus or begins to drop from the effect of Theta, the long puts should be sold for the premium that remains.
Profit: Close when the stock returns several dollars per share in profit. If the share price of the stock reverses direction and drops, sell the stock immediately. If the strike of the long puts moves deeper ITM, keep the long puts until the premium either achieves a profit or minimizes the loss from the stock. Then sell the remaining premium either for a profit or to minimize a loss.
Loss: The largest potential for a loss is if the share price of the stock begins a sustained price drop. Note that the long put’s premium value will increase as the price of the stock drops. However, the Delta value of each share of stock is 1.00, while the Delta value of an ATM option is 0.50—half that of the stock, itself. Delta increases incrementally as the corresponding option moves deeper ITM.