For some examples of strategies on options on the S&P 500 (SPX) Index, please click on any of the following:
Buy SPX LEAPS
SPX Protective Put
S&P 500 Protective Collar
SPX Synthetic -- Buy Call
For more information on some of the many ways in which listed options can help you manage your equity portfolio, please visit:
Investing & Risk Management Strategies
General Strategy Profit & Loss Diagrams
[The examples below are based on hypothetical situations and should only be considered as examples
of potential trading strategies. For the sake of simplicity, taxes, commission costs and other
transactions costs have been omitted from the examples that follow. Investors using index options
also may be subject to tracking error - which can be the unplanned divergence between the price
behavior of the underlying stocks and the price behavior of the index options used to hedge a
Investing and Risk Management Strategies
A. Protective Index Put Options to Hedge a Portfolio of Stocks
The purchase of stock index put options permits an investor to hedge equity market risk by limiting
downside risk while retaining upside potential. The premium paid is an upfront cost to the
As a hypothetical example, assume that in 1998 John Investor purchased a $2.3 million stock
portfolio that roughly matched the composition of the S&P 500 (SPX) Index. By 1999 the value of
John's portfolio had risen to $3 million.
In 1999 John decided he would like to lock in most of his $700,000 in gains. He was concerned
about maintaining the value of his stock portfolio because he anticipated incurring major expenses
over the next month, and he worried about stock market volatility and the stocks' relatively high
John decided he would like to reduce his exposure to a big drop in the equity market through the
next five weeks.
No sale of stock. He rejected the idea of an outright sale of some or all of his stocks for
several reasons - if he sold all the stocks he: (1) would incur capital gains tax; (2) would lose
the ability to pass on the stocks to his heirs with a "step-up" in tax cost basis after his death;
(3) might incur high transaction costs if he sold and then repurchased a large portfolio of stocks;
and (4) would lose the ability to participate in the upside of the stock market.
Purchase protective put options. Instead of an outright sale of his stock portfolio, John decided
to purchase S&P 500 (SPX) index put options expiring in five weeks as an aid to protect his $3
million equity portfolio so that he could participate in the upside of the market, while minimizing
transaction costs, taxes, and the risk of a large downside move.
Number of options needed for protection. With a recent price of the SPX index around 1350, the
formula for the amount of index options contracts needed to protect the portfolio is as follows:
divide the amount to be hedged ($3 million) by the underlying notional value for one SPX options
contract (1350 x $100 multiplier), or $3,000,000/$135,000, which equals approximately 22.2.
Fractional contracts are not available, so this number would be rounded to 22, and the outcomes
listed below could be subject to some rounding error. Thus, John could buy 22 SPX put options
contracts to hedge the portfolio.
Strike price for the options. John examined the prices for SPX index put options expiring the
following month, and decided to purchase "at-the-money" put options with a strike price of 1350.
The quoted price for the SPX index options with a strike price of 1350 was 32, so the amount that
John would need to pay now for protection is [32 (the quoted price)] x [$100 multiplier] x [22
contracts], which equals $70,400.
Possible Outcomes at Expiration
- The S&P 500 Index Remains Stable or Rises - At expiration, the puts would have no value, and
all the premium paid would be an insurance expense to the portfolio. The portfolio retains
any dividends associated with holding the assets. If the S&P 500 price level were to rise
above 1380, John could participate in some of the upside of the market (his upside is
reduced by the costs of the put premiums) and he might have a net gain on the overall
- The Index Falls - If the SPX index price level fell below 1320, the protective puts limit
the downside risk of the portfolio to approximately $70,400 (which is found by adding the
gain on the put options and subtracting the premium paid and the loss in the stock
portfolio's value). The portfolio retains any dividends associated with holding the assets.
The figure below graphs index value versus potential gain or loss.
B. Protective Collar with Minimum Net Premium Costs
Please note: Investors considering protective collar strategies should ask their brokers
about all costs involved, including margins and commissions.
Picking up on the facts from the above example, let's assume that John Investor wanted to hedge the
downside risk for his $3 million portfolio, but he would like to find a way to offset the cash
outlay for the put premiums.
One way to limit the net out-of-pocket cost for hedging protection is to use a protective collar
strategy, which provides downside protection through the purchase of index put options but finances
the purchase through the sale of short index call options, in effect trading away some upside
potential. By simultaneously purchasing put options and selling call options with differing strike
prices and the same expiration (the strike of the put is lower than that of the call), a collar
often can be established for little or no out-of-pocket cost. The index puts place a "safety net"
under a diversified portfolio by protecting value in a declining market, "insurance" against the
risk of a decline. The index call sale generates income to offset the purchase of the protective
puts, and it also limits upside gains.
It is important to note that, depending on the call strike price and the level of the index at
expiration, assignment of the short call position may have the effect of limiting portfolio gains.
Below is a profit-and-loss diagram showing a protective collar which has both upside potential and
downside risk limited to around $155,500 at expiration.
C. Long Index Call Options for Market Exposure
Call options allow investors to participate in upside moves in the market. The premium paid is an
upfront cost to the investor.
Let's assume that Jane Businessperson was bullish on the overall potential for the U.S. stock
market over the next 60 days, and she would like to somewhat diversify her exposure because most of
her net worth was tied up in one stock. She decided that she would like to participate in the
upside potential of stocks in the S&P 500 index, but also would like to place a known limit on her
cash outlay and her downside risk. Therefore, she decided to buy S&P 500 (SPX) index call options.
Number of options needed. With a recent price of the SPX index around 1380, the formula for the
amount of index options contracts needed to gain exposure is as follows: divide the amount to be
covered ($4 million) by the underlying notional value for one SPX options contract (1380 x $100
multiplier), or $4,000,000/$138,000, which equals approximately 28.99. Fractional contracts are not
available, so this number would be rounded to 29, and the outcomes listed below could be subject to
some rounding error. Thus, Jane could buy 29 SPX call options contracts to gain exposure.
Strike price for the options. Jane examined the prices for SPX index put options expiring the
following month, and decided to purchase "at-the-money" call options with a strike price of 1380.
The quoted price for the SPX index options with a strike price of 1380 was 42, so the amount that
Jane would need to pay now for protection is [42 (the quoted price)] x [$100 multiplier] x [29
contracts], which equals $121,800.
Possible outcomes at expiration. At expiration, if SPX price level were at or below 1380, the call
options would have no value and Jane's losses would be limited to the amount of upfront premium she
paid. If the SPX price level were to rise above 1380, she would have the potential to participate
in some of the upside of the market, but any upside is reduced by the cost of the call premium
paid. Below is the profit-and-loss diagram for this strategy.
Options Profit-and-Loss Diagrams
* In the Protective Put and Buy-write diagrams, the faint grey line represents an equity position, and the colored "hockey-stick-shaped" line represents the combined stock plus options position. For more details, please click on strategies
The CBOE S&P 500 BuyWrite Index (BXMSM) is designed to represent a proposed hypothetical buy-write strategy. Like many passive indexes, the BXM Index does not take into account significant factors such as transaction costs and taxes and, because of factors such as these, many or most investors should be expected to underperform passive indexes. Investors attempting to replicate the BXM Index should discuss with their brokers possible timing and liquidity issues. Transaction costs and taxes for a buy-write strategy such as the BXM could be significantly higher than transaction costs for a passive strategy of buying-and-holding stocks. Past performance does not guarantee future results. Standard & Poor's®, S&P®, and S&P 500® are registered trademarks of The McGraw-Hill Companies, Inc. and are licensed for use by the Chicago Board Options Exchange, Incorporated (CBOE). CBOE, not S&P, calculates and disseminates the BXM Index. The CBOE has a business relationship with Standard & Poor's on the BXM and PUT Indexes. CBOE S&P 500 BuyWrite IndexSM BXMSM are servicemarks of the CBOE. The methodology of the CBOE S&P 500 BuyWrite Index is owned by CBOE and may be covered by one or more patents or pending patent applications.
Options involve risk and are not suitable for all investors. Prior to buying or selling options, a person must receive a copy of Characteristics and Risks of Standardized Options(ODD). Copies of the ODD are available from your broker, by calling 1-888-OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606. The information in these materials is provided solely for general education and information purposes and therefore should not be considered complete, precise, or current. Many of the matters discussed are subject to detailed rules, regulations, and statutory provisions which should be referred to for additional detail and are subject to changes that may not be reflected in these materials. No statement within these materials should be construed as a recommendation to buy or sell a security or to provide investment advice. Any strategies discussed, including examples, do not include commissions, dividends, margin, taxes, and other transaction costs. However, these costs will affect the outcome of transactions and should be considered. S&P 100 and S&P 500 are registered trademarks of the McGraw-Hill Companies, Inc., and are licensed for use by the Chicago Board Options Exchange, Inc. (CBOE). The "Russell 2000 Index is a registered trademark of Frank Russell Company. The Nasdaq 100 is a registered mark of The Nasdaq Stock Market, Inc. "Dow Jones SM", Dow Jones Industrial AverageSM", "Dow Jones Transportation AverageSM," and "Dow Jones Utility AverageSM" are service marks of Dow Jones & Company, Inc. and have been licensed for certain purposes by the CBOE. LEAPS, FLEX, FLexible EXchange, CBOE, Chicago Board Options Exchange and OEX are registered trademarks of CBOE, and Long-term Equity AnticiPation SecuritiesTM and SPXTM are trademarks of the CBOE.
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