One of the central benefits of producing its Walk the Tightrope report is that it provides a useful framework for SSGA to discuss with investors the ways they are approaching risk management, and identify ways in which they can help establish a multi-pronged solution to downside protection. Other times, we don't know what will occur, when it will occur, or even if it will occur. Learn what a long position in a stock is, what a call option is, and the difference between owning shares of a company and It's important to remember that you're not necessarily trying to make money off the options but are instead trying to ensure your unrealized profits don't become losses. That is a very simplistic mind set, and symptomatic of investors having an inchoate understanding of different risk tools.
Downside protection on an investment occurs when the investor or fund manager uses techniques to prevent a decrease in the value of the investment. It is a common objective of investors and fund managers to avoid losses and many instruments can be used to achieve this objective.
BREAKING DOWN 'Downside Protection'
Think of options as the building blocks of strategies for the market. Options have been around since the market started, they just did not have their own spotlight until recently. Bearish options strategies are employed when the options trader expects the underlying stock price to move downwards. It is necessary to assess how low the stock price can go and the time frame in which the decline will happen in order to select the optimum trading strategy.
Selling a Bearish option is also another type of strategy that gives the trader a "credit". This does require a margin account. The most bearish of options trading strategies is the simple put buying or selling strategy utilized by most options traders. Stock can make steep downward moves. Moderately bearish options traders usually set a target price for the expected decline and utilize bear spreads to reduce cost. This strategy can have unlimited amount of profit and limited risk when done correctly.
The bear call spread and the bear put spread are common examples of moderately bearish strategies. Mildly bearish trading strategies are options strategies that make money as long as the underlying stock price does not go up by the options expiration date. However, you can add more options to the current position and move to a more advance position that relies on Time Decay "Theta".
These strategies may provide a small upside protection as well. In general, bearish strategies yield profit with less risk of loss.
Neutral strategies in options trading are employed when the options trader does not know whether the underlying stock price will rise or fall. Also known as non-directional strategies, they are so named because the potential to profit does not depend on whether the underlying stock price will go upwards.
Rather, the correct neutral strategy to employ depends on the expected volatility of the underlying stock price. Neutral trading strategies that are bullish on volatility profit when the underlying stock price experiences big moves upwards or downwards.
They include the long straddle , long strangle , short condor Iron Condor , short butterfly, and long Calendar. Neutral trading strategies that are bearish on volatility profit when the underlying stock price experiences little or no movement. Such strategies include the short straddle , short strangle , ratio spreads , long condor, long butterfly, and long Calendar or Double Calendar. These are examples of charts that show the profit of the strategy as the price of the underlying varies.
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In recent years, however, evidence suggests that assets that were once non-correlating now mimic each other, thereby reducing the strategy's effectiveness. Why It's Still Hip. Investors generally protect upside gains by taking profits off the table. Sometimes this is a wise choice. However, it's often the case that winning stocks are simply taking a rest before continuing higher.
In this instance, you don't want to sell but you do want to lock-in some of your gains. How does one do this? There are several methods available. The most common is to buy put options , which is a bet that the underlying stock will go down in price. Different from shorting stock, the put gives you the option to sell at a certain price at a specific point in the future.
You're convinced that its future is excellent but that the stock has risen too quickly and likely will decline in value in the near term. At this point, you sell the option for a profit to offset the decline in the stock price. Investors looking for longer-term protection can buy long-term equity anticipation securities LEAPS with terms as long as three years.
Long-Term Equity Anticipation Securities: It's important to remember that you're not necessarily trying to make money off the options but are instead trying to ensure your unrealized profits don't become losses.
Investors interested in protecting their entire portfolios instead of a particular stock can buy index LEAPS that work in the same manner. Stop losses protect against falling share prices. Hard stops involve triggering the sale of a stock at a fixed price that doesn't change.
A trailing stop is different in that it moves with the stock price and can be set in terms of dollars or percentages. What happens next determines which is more advantageous. Proponents of stop losses believe that they protect you from rapidly changing markets.
Opponents suggest that both hard and trailing stops make temporary losses permanent. It's for this reason that stops of any kind need to be well planned. Investing in dividend-paying stocks is probably the least known way to protect your portfolio.
Historically, dividends account for a significant portion of a stock's total return. In some cases, it can represent the entire amount.
Owning stable companies that pay dividends is a proven method for delivering above-average returns. When markets are declining, the cushion dividends provide is important to risk-averse investors and usually results in lower volatility.
In addition to the investment income , studies show that companies that pay generous dividends tend to grow earnings faster than those that don't. Faster growth often leads to higher share prices which, in turn, generates higher capital gains. In addition to providing a cushion when stock prices are falling, dividends are a good hedge against inflation.
By investing in blue chip companies that both pay dividends and possess pricing power , you provide your portfolio with protection that fixed income investments , with the exception of Treasury inflation-protected securities TIPS , can't match.
Aug 06, · In this column, I’ll discuss three downside protection strategies for nervous investors –options, variable annuities and asset allocation—but before that, for context, let’s review some recent market history. By almost any yardstick, the market has been relatively stable recently. Definition: Downside protection is a strategy implemented in options to hedge the risk of volatility and lower or eliminate the losses of a portfolio in case the . To protect your profits, you buy one put option of Company A with an expiration date six months in the future at a strike price of $, or slightly in the money. The cost to buy this option is $ or $6 per share, which gives you the right to sell shares of Company A at $ sometime prior to its expiry in six months.