Navigating Volatility and Misconceptions: Using Options Strategies to Define Your Risk
As markets continue to fluctuate, it's important to understand how to use options to protect your stock portfolio and achieve your financial goals.
The market is always changing and it can be difficult to predict where it's headed next. While the current market conditions may seem favorable, a recession or other unexpected event could cause a market correction. The goal of this article is to help you understand how to use options strategies to reduce volatility in your stock portfolio and achieve your personal financial goals and objectives.
Options strategies can help you generate income and reduce your risk exposure. In this article, we will cover three popular options strategies: Cash Secured Puts for a Buy Strategy, Covered Calls for a Sell strategy, and Collar for dividend stocks or concentrated stock positions.
Cash Secured Puts for a Buy Strategy:
A cash-secured put is an options strategy that can help you generate income and reduce your risk exposure when buying stocks. This strategy involves selling a put option and having the cash on hand to buy the stock if the option is exercised. By selling a put option, you collect a premium, which can offset the cost of buying the stock. If the stock price falls below the strike price of the put option, you can buy the stock at a lower price.
Covered Calls for a Sell strategy:
A covered call is an options strategy that can help you generate income and reduce your risk exposure when selling stocks. This strategy involves selling a call option and having the stock on hand to sell if the option is exercised. By selling a call option, you collect a premium, which can offset the loss of potential gains from selling the stock.
Collar for Dividend Stocks:
A collar is an options strategy that can help you generate income and reduce your risk exposure when holding dividend stocks. This strategy involves selling a call option and buying a put option. By selling a call option, you collect a premium, which can offset the loss of potential gains from holding the stock. By buying a put option, you protect yourself against a potential drop in the stock price.
Protective Puts (Hedge a concentrated stock portfolio):
Protective Puts can also be a great way to hedge a concentrated stock portfolio, such as exercised incentive stock options (ISOs) that are now stock with short-term gains. By purchasing a put option on these concentrated positions, investors can protect themselves against a significant drop in the stock's value while still participating in any upside potential. This strategy can be especially useful for those who have a significant portion of their portfolio invested in a single stock and want to limit their risk exposure. It's important to note that while protective puts can provide a hedge against downside risk, they also come at a cost, as the premium for the put option must be paid. Additionally, like all options strategies, protective puts come with their own set of risks and should be thoroughly researched and understood before implementing.
In conclusion, understanding the popular misconceptions and biases that investors have regarding major market events, diversification, and risk can help to redefine portfolio construction and risk management. By implementing options strategies such as cash secured puts for a buy strategy, covered calls for a sell strategy, and collars for dividend stocks or concentrated stock positions, investors can generate income and reduce their risk exposure in their stock portfolios.
To further educate yourself on options strategies, we recommend visiting the OIC Industry Council website and utilizing their options strategy builders and options quotes tools. Additionally, there are plenty of other resources, references, learning materials, and articles available to those who have invested in stocks but not yet in options. By taking the time to educate yourself on the benefits and potential risks of options trading, you'll be better equipped to navigate the markets and make more informed investment decisions.
Additional educational resources:
CBOE Options Institute, a comprehensive resource for options education
Tastytrade, a financial network that provides options education through its website and TV show
Options Animal, an options education and training program
In addition to implementing options strategies on a stock portfolio, investors can also consider utilizing exchange-traded funds (ETFs) that focus on options-based strategies. These ETFs are managed by professional portfolio managers who use options to generate income and reduce risk exposure for the fund. Another option for investors is to work with a financial advisor to set up a separately managed account (SMA) that utilizes options strategies. These accounts are tailored to the specific goals and objectives of the individual investor and are managed by a professional portfolio manager.
Some of the asset managers utilizing options:
Swan Global Investments, established in 1997 and offers Hedged Equity solutions
WisdomTree (PUTW)
It is important to note that while options strategies can be used to generate income and reduce risk exposure, these options strategies and tools can be complex and it's essential to educate oneself thoroughly before implementing them in a portfolio. It is crucial for investors to understand the potential risks associated with options trading before implementing any strategies. Some of these risks include the potential for loss of the entire premium paid for an option, the potential for the underlying stock to be called away, and the potential for the option to expire worthless. It is also important to note that past performance is not indicative of future results. As always, it's important to consult with a qualified financial professional, and understand the risks involved before making any investment decisions.
Disclaimer. This post is for general information purposes only. It does not constitute investment advice or a recommendation or solicitation to buy or sell any investment and should not be used in the evaluation of the merits of making any investment decision. It should not be relied upon for accounting, legal or tax advice or investment recommendations.