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The 6-Week Options Trading Kickstarter: Hedging, Portfolio Protection, and Avoiding Disaster

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Steve Smith discusses using options to protect your positions and portfolio.

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2. The next step is to sell a call spread for a credit, such as selling the January $145 calls and buying the January $150 calls. This call spread can garner about a $1.50 net credit. Remember, as a spread, this won't limit your upside. You could probably sell up to about 50 or 60 of these spreads. Just be aware that there's a "dead zone." If SPY is between 145 and 150, then you'll lose $3.50 on this position. But I assume you'd be making money if stocks rallied another 10% from current levels. You can use higher strikes or sell fewer spreads to align with your risk profile.

3. Finally, use the proceeds of the call spreads to buy some out-of-the-money (or OTM) puts outright to provide deeper downside protection. For example, the $7,000 proceeds from the call spread would finance the purchase of about 20 of the January $117 puts. These OTM puts give you outright disaster protection should the market head back towards last October's lows near the $110 level.

The total outlay would be about $11,000 -- or about 7% of the $150,000 portfolio -- which isn't too steep for over six months of portfolio insurance.

This is just a loose construct -- you can play around with the numbers -- but I think the best hedges will ultimately involve more than simply picking one strike.

Now if you're ready take on some more advanced options concepts, I suggest you read my 9 Weeks to Better Options Trading series.

Twitter: @steve13smith

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No positions in stocks mentioned.

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