Buying Equity LEAPS Puts To Hedge The Value Of Stock Owned

The LEAPS Option Strategy Workshop is a collection of discussion pieces designed to assist individuals in learning how options work and in understanding various LEAPS options strategies. These discussions and materials are for educational purposes only and are not intended to provide investment advice.

Investment decisions should not be made based upon worksheet outcomes.

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Buying Equity LEAPS Puts To Hedge The Value Of Stock Owned

Stock Assumption: Bearish
Situation: Investor believes prices on certain stocks will decline over the next two years
Possible Market Action: Buy LEAPS Puts to hedge the value of stock owned

An investor has purchased stocks in many individual companies over time and has substantial paper profits but is now concerned about a decrease in price over the next two years. He does not want to be forced to sell these stocks and also is not sure when a softening in price will occur. LEAPS offer a means to maintain ownership as well as protect a defined amount of the value of a stock.

ZYX is trading at 110 and the 2 year January, 95 LEAPS® put is trading at 4. The individual owns 500 shares which were purchased at an average price of 75. He is hoping the stock will continue to appreciate but would like to lock in a profit without putting a cap on how high ZYX can be sold. Purchasing the 2 year January, 95 LEAPS puts gives him the right to sell this stock at a price of 95 until the expiration date irrespective of how much of a decline might occur. Should the price of ZYX decline, the value of the puts would generally increase and therefore cover some of the decline in value of the stock.

The investor buys five LEAPS puts for $2,000. He is risking this amount plus commissions if ZYX is not below 95 at expiration.

If ZYX declines to 90 within a year, the value of the LEAPS will be approximately 6.875. They can be sold for a profit which will offset some of the recent paper loss on the stock or they can be held as continued insurance for the remainder of the two year term.

Buy Five LEAPS ZYX 95 Puts

Closing Sale Price (5 x 100 x 6.875): $3,437.50
Less premium paid (5 x 100 x 4): $2,000.00
Profit on the LEAPS® puts in this situation: $1,437.50

Commissions, dividends, margins, taxes and other transaction charges have not been included. However, they will affect the outcome of option transactions and should be considered. The strategy discussed above is for illustrative and educational purposes only and should not be construed as an endorsement, recommendation or solicitation to buy or sell any particular security.