Enhanced Indexing Strategies: Utilizing Futures and Options to Achieve Higher Performance

CHAPTER 10

Practical Hedging with Put Spreads

The last few chapters presented a number of different investment strategies using long and short call options to capture long-term profits from the index. Typically the long call options provided the profits, while the short call options helped lower the initial investment and manage the risk.

This chapter presents investment strategies using long and short put options; as a result, the roles of the long and short options change. Long put options primarily control portfolio risk, while short put options help fund the purchase of long options and also provide investment profits.

Much of the emphasis of the chapter is on portfolio protection, and assumes that the investor is holding a leveraged long index portfolio using call options, index futures, or some similar security. However, because put options are very expensive, the addition of short put options is often needed to make a hedging strategy more affordable and cost-effective.

Two bullish strategies are also discussed: the bull put spread and the calendar put spread. Bull put spreads have some flaws that make consistent profitability difficult, and as a result more time is spent discussing calendar put spreads. These positions can be extremely profitable and can also provide enormous flexibility when used in conjunction with a leveraged portfolio.

ABOUT PUT OPTIONS

A put option is a hedging tool that allows an investor to eliminate some or all of the downside risk of a security ...