The Weekly Strategy Discussion is designed to assist individuals in learning how
options work and in understanding various options strategies. Options involve risk and are not suitable
for all investors. The strategies discussed are for educational and illustrative purposes
only, and should not be construed as an endorsement, recommendation or solicitation to buy or
sell securities. Commissions, taxes and transaction costs are not included. Please contact a tax advisor for the tax implications involved in these strategies.
Protecting a Diversified Portfolio
Example: Investor owns a $300,000 portfolio which closely follows the S&P 500 Index (SPX).
Outlook: Investor has enjoyed a nice run but is worried about a possible market pullback.
Possible strategy: Purchase SPX put options for portfolio protection.
Determine # of SPX Put Contracts Required for Protection
- Portfolio $Value to be Hedged/Notional Value of Index Contract (Strike x $100)
- $300,000/1560 x $100 = 2 SPX puts
- Buy 2 SPX June 1560 Puts @ $41.00 ($4100/Contract)
How the Protection Works
- Assume SPX 1,248 at expiration
- Market is down 20%
- $291,800 stock portfolio now worth $233,440
- 1560 Puts @ $312
- Value of puts: $312 x 2 x 100 = $62,400
- Total Portfolio: $233,440 + 62,400 = 295,840
In Summary: Stock prices tend to move in tandem in response to the overall stock market as measured by the S&P 500 Index (SPX). The 500 stocks that comprise the S&P 500 Index represent almost 85% of the stock market value in the United States. Therefore, the index is an excellent reflection of the overall stock market. If an investor owns a portfolio of stocks and is concerned about a near-term downward move in the overall market, purchasing the appropriate SPX put options could be a desirable alternative to hedging each stock individually.