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A) THE SHORT VERSION: 4 Steps using the oscillator
STRATEGY 1: When I can watch the market throughout the day
STRATEGY 2: When I am unable to watch the market during the day




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Feb 12 2010  / Strategy Discussion

Many times I cannot be in front of the computer all day long. After all, there is a life beyond trading stocks! How do I handle hedging my portfolio in a market downturn when I cannot watch the market during the day? To begin let me repeat some of the information from Hedging Strategy 1. If you have already read it, my apologies, but it bears repeating:

In a market downturn I like the SPY puts. For me the biggest reason besides having used them for years, is because they have good premium and as they follow the S&P accurately, premiums are always decent and reasonable. In a downturn, volatility will force up the premiums. I always try to buy 2 months out and slightly in the money.


The Ultra shorts are not my choice and I have never used them on the S&P. The problem with the Ultra Shorts I have found from back testing, is that when the market moves against me, losses can be large. Unless I get out quickly I can be looking at larger losses than the puts, not always I suppose, but certainly when I have studied the Ultra Shorts, it does appear to me that the SPY puts are better to hold. It's my choice, but definitely by volume, I can tell I am in the minority. The Ultra Shorts are very popular. 

Buying puts is tough for a lot of people as it is going against how we are taught about investing. We are all fed the story of stocks moving higher. Why then buy puts? Simply because the market trend at times is down and not up. When this happens I have to decide if I have faith in the market call. When I buy a put and the market moves higher, which often happens, I am looking at a loss. I have to decide if I can stand the loss. It's a question of building my confidence in my ability to read the market signs and believe in my purchase of puts to hedge my positions.


Remember as well two key points:

1) I have confidence that the market is moving lower, so that means if by chance I buy my puts at the wrong moment I have confidence that the market will move lower than where I bought them, perhaps not today, but maybe tomorrow. If I do not have this confidence I will second guess myself and hesitate when I select the moment to buy and sell my puts. That hesitation could mean poor entry and exit points which will impact my profit.

2) I want to build up a cash cushion to assist me when the market turns and my put buying will be the incorrect strategy. A cash cushion insures that I have a profit from the market downturn.

When I am unable to be in front of my computer throughout the day, here is how I trade the SPY puts in a downturn. (make sure to read the Summation at the bottom of this article for more details on how I leg into and out of my puts) I try to always stay just slightly in the money (ITM) when I buy the puts. I never buy the closest month. I always buy the next month out. This is because premium decreases quicker in the closest month. If my market timing was wrong and the market turns up NOT down, the closer month will lose premium more than the next month out. It goes without saying then, that if the market is indeed falling, the closer month's puts will not have as much premium as the next month out.


As to the number of put contracts bought, I believe it all depends on an investor's comfort level and the amount of stock they are holding. If I was holding 2000 shares then perhaps 10 puts is comfortable. Every investor has a different level. Primarily I am seeking some capital income from a market downturn. Therefore I set aside an amount of capital and that determines how many puts I can afford to buy. In 2010 for example I set aside 12,000 for Spy put purchases.


For our example (remember this is an example) on how I would trade the SPY puts to hedge myself, knowing I am unable to monitor the market during the day, let's look at the period Friday Jan 22 2010 (below). I first became convinced that it would be best to buy puts as the market was in my opinion going to move lower.

FRIDAY JAN 22 2010
On Friday Jan 22 2010 I decided it was time to buy puts. That evening I check the charts and I can see that most of the day the market traded above 110.00. I check the Mar 20 110 Puts and find the high and low for the day. I take the average, which for the day was $3.65. Before going to bed, I put in my order to buy 20 Puts Mar 110 at $3.65, good for the day. REMEMBER depending on your discount broker, you want to place a contingent stop loss at the time of placing your buy order. If I am filled for example at $3.65, but the market is actually turning to move higher I might come home to find out that I was filled at $3.65, but the put is now trading for $2.50. When placing my order to buy I always place my stop loss at the same time, contingent on my being filled. In this instance my stop loss would be $3.15.



MONDAY JAN 25 2010

I am busy all day and unable to check the markets. I have no idea if I have been filled on my position at $3.65. I rush home and check my computer. Here is what I see. The market didn't go anywhere to speak of. I was filled in the morning and my stop loss was not hit. I now put in my new stop loss. I don't want to be whipsawed in the event of a bounce as I know support is around 108. I put in my stop loss at $3.15, for a loss of .50 or $1000.00, should I be taken out. I also know that I need to build a cash cushion to assist in the event that this downturn is just a two or three day affair and the market actually moves higher perhaps by the end of the week. I look at the high and low on the 110 PUT for today. I see the high was $4.65 and the low was $3.50 (Remember these are puts so the high will be the lowest point of the day and the low the highest point of the day on the S&P) I know the chance of getting the low of the day is not as probable as perhaps getting close. With my puts at $3.65, I decide to place my order to sell at $4.35. This is a .70 cent profit or $1400.00. If this should occur, I will have a cushion to cover any loss up to $.70 cents. With both my stop loss and order to sell now placed, good for the day, I head off to bed.


In the evening on Tuesday I check the chart and here is what I see. The market opened lower, ran up and then basically ended where it started. Not a good sign for the market. I did not get sold out, but I may tomorrow.

Wednesday Jan 27 2010

When I check the charts in the evening and my account I see that I sold at $4.35 in the afternoon. I now have a 1400.00 cushion. The market though is not trending higher. It came close to the $110 strike but not enough. It still appears that the market is moving lower and my 10-20-30-50 chart is showing the market is under a lot of stress now. I want to buy my SPY puts again, but I know the 110.00 is going to be difficult to get for $3.65. Instead I put in my buy for the 110 puts at $3.95. My original purchase was at $3.65. My sell was $4.35. 50% difference puts me in at 4.00. I opt for $3.95, but even 4.00 would be good. My order is placed at $3.95 good for the day and I head to bed.


Thursday Jan 28 2010

In evening I come home to find out that first thing in the morning the market traded higher and I was filled at $3.95 to buy 20 Naked Puts Mar 20 2010 at $110. When I look at the chart I also see that if I had just a moment at lunch to check my account, I could have put in an order to sell at $4.30 or even a bit lower and I would have been filled when the market fell in the afternoon briefly around 1:30. Well there isn't anything I can do about that, as I was at work and didn't have a moment. Now though, that the day is finished I can reassess my situation. I have raised $1400 for a cash cushion and I am back holding 20 Put Contracts at a cost of $3.65. I could either hold these for another day, or I could try to raise some more cash. The market continued to bounce off the 108, which is the support. It is either going to continue like this for a few days or will eventually bounce higher or lower. I don't have to be a genius to figure this out. I can afford a $1000 loss as I now have a $1400.00 cushion. That will place my stop loss at $3.45. I place my stop loss at $3.45 and then decide I would like to try to sell the puts again and increase my cash cushion. I want to try for a 10% gain in the option price which would place me around $4.35. I would really like to get a little bit more so I look at the VIX. (See second chart below Thursday SPY chart) and I notice that the volatility is actually starting to decrease. That's primarily because we are bouncing around at support. I decide I will stay with 10% and I place my order to sell at $4.35 - good for the day and head to bed.



Friday Jan 29 2010

I heard on the news that the market had pulled back so I am anxious to get home and check my account. Sure enough I was filled at $4.35 for a gain of $800.00. Now I have a cushion of $2200.00. I see also that we broke through the 108 support and momentum was decidedly negative. I check the option range for the 110.00 put strike and I find it is now over $5.00 on the high side so I decide to move to the $109.00 For Friday, the $109 PUT traded between $3.15 to $4.60. The 50% retracement mark would put the price at about $3.80. There could be a decent bounce on Monday or we could sell off more. I decide Friday night that I will now put in an order to buy 20 puts on the SPY March 20 strike $109.00 at $3.65 good for the day. I now have a $2200.00 cushion so I decide I can risk $1800.00 of it. I place a contingent order, if I am filled at 3.65 to place my stop loss at $4.55. That gives the market plenty of room on the upside so if I get a fill and it bounces higher I might not get taken out. Now I just have to wait until Monday. 


There are many different ways to trade the SPY aside from the example I have given above. You could place smaller orders to try to leg into the SPY over a period of different prices. For example on Friday Dec 22 you could place a good for the day order to buy the $110.00 put starting at 5 contracts at the previous days high, then 5 contracts .20 cents lower and 5 contracts .40 cents lower, etc.

Something like this:

BTO 5 contracts March 20 2010 $110.00 put @ 3.05
BTO 5 contracts March 20 2010 $110.00 put @ 3.25
BTO 5 contracts March 20 2010 $110.00 put @ 3.45
BTO 5 contracts March 20 2010 $110.00 put @ 3.65


The same strategy can be used on the sell. You could place your sell prices staggered so as to reap a better return if the market continued to move lower through the day. You might come home to find that you have sold 10 contracts and still hold 10 contracts.


Another variation is to place your order to sell on just half of your contracts and retain the other half for the next upcoming day.


****My choice when I am unable to watch the market throughout the day is to place a staggered price list for the buy and the same on the sell side. I have always found that the market moves around more than people expect and I often get a variety of fills and much better pricing, both on the buy and sell side.

As well, when I am busy I still try to take a moment to check my account around lunch hour. If I have been filled on my buy side, I normally check the high put price for the day and I will place an offer to sell on at least some of the puts I have received, at just slightly less than the high put price. For example if the high was $5.10, I might ask $5.00. That way if 5 contracts are filled I have made a profit to begin to build my cash cushion. The more days I can trade in and out of the spy, the larger my cash cushion becomes giving me better flexibility on my stop loss prices to avoid being whipsawed around. I rarely buy puts and hold them for days to see where the market is going. If I have confidence that the market is moving lower, than I want to begin building my cash cushion now, because I know at one point I will be wrong and the trade will move against me as the market turns and moves higher. When that time comes my cash cushion that I have built up, will provide me with the protection I need to come out of the downturn with a profit. On put buying my rule is, leg in and out and trade often. The market moves around a lot in a day and you can get filled more than once during a day.



A) THE SHORT VERSION: 4 Steps using the oscillator
STRATEGY 1: When I can watch the market throughout the day
STRATEGY 2: When I am unable to watch the market during the day






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