Options Strategies

Strategy Number 7 – Long "Covered" Put

Market dATA
DJ Index 100 points
Prices
Base asset price $10,000

Put 100 $1,000
Strategy name:

Long "Covered" Put

Recommended use of strategy

Expectation of an increase in DJ Index, but with concern that the index could fall.

 

Strategy components

  1. Purchasing (Long) the base asset – the DJ Index or a mutual fund investing in the DJ shares (see page 9).
  2. Purchasing a Long Put option at a strike price equal to the DJ Index.

Example: Purchase (Long) the base asset at a price of $10,000 and purchase a Long Put 100 option for $1,000. The strategy is known as a Short Futures Contract since this combination creates an obligation (contract) to sell the DJ Index at the exercise date at its current price (100 points - $10,000).

Expenses / Income from building the strategy

Expenditure of $11,000.

Strategy graph:

graph

Auxiliary table for building the profit line  

 

 

DJ Index
(Horizontal axis)
(Fixed expenses)/ fixed income Variable expenses
(Put contribution)
Base Asset contribution Total profit / (loss) 
(Vertical axis)
2+3+4
1 2 3 4 5
60 $11,000 $4,000 $6,000 ($1,000)
70 $11,000 $3,000 $7,000 ($1,000)
80 $11,000 $2,000 $8,000 ($1,000)
90 $11,000 $1,000 $9,000 ($1,000)
100 $11,000 --- $10,000 ($1,000)
110 $11,000 --- $11,000 $0
120 $11,000 --- $12,000 $1,000
130 $11,000 --- $13,000 $2,000
140 $11,000 --- $14,000 $3,000
150 $11,000 --- $15,000 $4,000          

Strategy analysis:

Source of profit        

The profit arises from the investment in the mutual fund. The profit increases as the index goes up.

Source of loss           

Cost of building the strategy - $11,000. However when the DJ Index goes down, we lose on the mutual fund investment but are fully compensated by the Put option.

Break-even point     

This occurs at index 110.

Comment                  

This strategy is a form of purchasing "insurance" against the risk of a fall in the value of the DJ Index shares basket.

Strategy Number 7 – Long "Covered" Put593Strategy Number 7 – Long "Covered" Put