Options: Protective Put

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Options: Protective Put

Strategy

We are assuming that;

  • we already own 100 shares of AAPL at $95 cost
  • we want to protect our portfolio against possible short term AAPL price drops
  • we are not paying any premium for the options we are buying
  • we are considering only the intrinsic (exercise) value of the option
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    Simulating the spot price

  • We will simply simulate (increase and decrease) the daily price
  • This is to see the reaction in the option prices
  • Example: what if the price of AAPL goes up to $100
  • Example: what if the price of AAPL goes down to $80
  • I chose 2% daily change arbitrarily.
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    Return on AAPL investment

  • Just on the AAPL investment (ignoring the put option): How much money do we earn as AAPL price goes up?
  • Just on the AAPL investment (ignoring the put option): How much money do we lose as AAPL price goes down?
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    Put option value

  • Now, as the price of AAPL changes, the exercise value of the put option will change
  • We will exercise the put option only if the exercise price is higher than the spot price
  • We will not exercise the put option if the exercise price is lower than the spot price
  • Therefore, the exercise value for the put option cannot be a negative value
  • Note that I am using Open Office (FREE – I hate MSFT). So, replace “;” with “,” if you are using MS-Excel. Or get Open Office.
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    Portfolio profit and loss

  • Our portfolio consists of the AAPL stock and a put option
  • So, the profit and loss on the stock investment is combined with the put option outcome
  • Notice that while we are making profit on the portfolio as AAPL price goes up, we are not losing any money as it goes down
  • Note however, we ignored any option premiums that we would normally pay to buy the put option.
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