Triple Play Hedge
Grasshopper, sit down, I want to teach you something.
When it comes to Triple Play Hedge you are all Grasshopper! Experienced traders along with beginners have never heard of Triple Play Hedge because it’s not in any books or stock option material. It’s a strategy I’ve been working on that I came up with to solve a problem. I guess you can say I’m the inventor. The problem I’m trying to solve is hedging, or I should say paying for hedging.
Grasshopper, before you get into this strategy you must completely understand Covered Calls and Naked Calls. Also read up on Hedging, but we will go over Hedging a little on this page.
To hedge a position is to have insurance on a position. It’s a conservative strategy used to limit investment loss. It can be a transaction which offsets an existing position or getting into two position trades at the same time. There are different ways to hedge or get insurance but most hedging, when it comes to trading options, you have to pay for; paying for insurance. All hedging involves having a position you bought, and a position you sold. Your initial position, whether bought or sold, is protected by another position doing the opposite, buy or sell. The reason I’m working on this new strategy, Triple Play Hedge, is because I don’t like the price of insurance with traditional option hedging. All the books say, “would you own an asset without insurance?”, “would you own a home without having insurance?” Well no, but my home insurance is $1500 a year. When insuring an option it sometimes cost you 50 to 75% of what you received as a premium when selling an option. My point is, in many cases I think hedging is too expensive! But if you’re a high risk trader, you must use it. Let’s take a look at a few examples of hedging.
Example #1: Spreads – An options spread is any combination of multiple positions. This can include buying a Call and selling a Call, buying a Put and selling a Put, or buying stock and selling the Call (which would be a covered write). There are so many types of spreads, and strategies involving more than one spread, we cannot cover all in this section. The point is, when using spreads we are buying something and selling something to hedge and have insurance on our investments to manage risk.
Example #2: Buy 1 stock and hedge by shorting another stock that would normally go down when the industry of the 1st stock goes up or vice versa. An equity long-short strategy is an investing strategy, used primarily by hedge funds, that involves taking long positions in stocks that are expected to increase in value and short positions in stocks that are expected to decrease in value. If the price of oil is moving down we might want to invest in an airline company because that industry will get a push because of higher profits. To hedge this investment, we might also short an oil company which would move down because of lower profits.
Hedge funds using equity long-short strategies simply do this on a grander scale. At its most basic level, an equity long-short strategy consists of buying an undervalued stock and shorting an overvalued stock. Ideally, the long position will increase in value, and the short position will decline in value. If this happens, and the positions are of equal size, the hedge fund will benefit. That said, the strategy will work even if the long position declines in value, provided that the long position outperforms the short position. Thus, the goal of any equity long-short strategy is to minimize exposure to the market in general, and profit from a change in the difference, or spread, between two stocks.
Example #3: Protective Puts (buying) -The protective Put, or Put Hedge, is a hedging strategy where the holder of a stock buys a Put to guard against a drop in the stock price of that security. If you bought XYZ Corp for $10 per share and it goes up to $20 per share, to protect against any sudden down turn, you might want to buy a Put on the stock. When you buy a Put, the value of the Put goes up as the value of the stock goes down. In doing so you lock in profit you already have on the stock while not selling your stock.
As you see in these few examples, if you want a little insurance on your investment you have to spend some money and/or sacrifice some of your potential profit to have insurance against an unfavorable movement in your investment. What I’m trying to accomplish with my Triple Play Hedge is to have a nice amount of insurance against an unfavorable move in my investment without paying, and actually getting paid to have it without exposing myself to a large amount of risk.
Grasshopper, let me be very clear. Hedging (having insurance) is a very important part of being an options trader. All traders hedge! Including me. I am just trying to use my strategic coaching brain and developing a way to get insurance and actually get paid for it. Let’s get into my Triple Play Hedge.
As you probably know by now I don’t like owning stock. This does not mean I never own stock. If I do own stock I am selling Covered Call on that stock. You must study this strategy by going to my page titled “Covered Calls.” When selling Calls you receive money called a premium. You can sell Covered Calls and you can sell Naked Calls. When selling a Call on a stock you own, this is a Covered Call. There are many reasons for doing this. One of the reasons is to bring in money to protect your investment against a downturn in your stock. When owning a home you have insurance to protect yourself against any property damage. When owning a stock you can sell a Call and receive money which is insurance against and damage to the stock. Let’s say you own a stock that cost you $20,000 to buy. You sell a Call option that brings you a premium of $2000. That stock can go down to $18,000 in value. You didn’t lose any money because the stock went down $2000 but you brought in $2000 on the sale of the Call Option. You are even! You had insurance and you didn’t pay for it, you actually got paid. The only problem is with this insurance you are covered only by the amount of the premium ($2000). I want more insurance! This is where my Triple Play Hedge comes in.
The Triple Play Hedge involves owning stock and selling a Covered Call. In addition I sell 2 more Calls. These are Naked Calls because I do not own the additional stock to make these Covered Calls. I have been practicing this strategy as paper trades. A paper trade is a trade made only on paper and not in my account with real money. Below you will see the first real Triple Play Hedge I’ve done. This is a real trade I made on November 11, 2015, right before I started blogging.
My First Triple Play Hedge
Date: Nov 11, 2015 Stock: Netflix Purchase Price of Stock: $113.50
With my first Triple Play Hedge I owned 1000 shares of NFLX. For the 1st leg I sold 10 contracts of the 11/13/15 $115 Call and received a premium of $1.30. This was a 2 day option and the premium was $1300. This in it’s self is a Covered Call. The 2nd leg I sold 10 contracts of the 11/20/15 $120 Call and received a premium of $1.05. This Expiration Date was extended a week and the Strike Price was $7 Out-of-the-Money, the premium was $1050. This is a Naked Call. For the 3rd leg, I sold 10 contracts of the 11/27/15 $123 Call and received a premium of $1.00. This Expiration Date was out another week and the Strike Price was $10 Out-of-the-Money, the premium was $1000. This is another Naked Call.
In total, I own 1000 shares or NFLX and I sold 30 contracts of Calls, 10 Covered Calls and 20 Naked Calls. The Triple play brought in a total premium of $3350. This is $3350 I got paid and I have insurance against the stock going down. Getting paid for insurance! Here are the orders for the options:
#1 – Sell to Open 10 NFLX 11/13/15 $115 C @ $1.30 (+$1300) (Covered Call)
#2 – Sell to Open 10 NFLX 11/20/15 $120 C @ $1.05 (+$1050) (Naked Call)
#3 – Sell to Open 10 NFLX 11/27/15 $123 C @ $1.00 (+$1000) (Naked Call)
I give this a Risk Factor of 3 because it involves 2 Naked Calls. If it was a stand alone Naked Call I would have a higher Risk Factor but the 1st leg is a Covered Call and the 2 Naked Calls are $7 & $10 Out-of-the-Money. Let’s look at some possible outcomes.
On 11/13/15 NFLX same price: My $115 Call would expire worthless and I keep the $1300 premium of the 1st leg. I have 1 week left for the 2nd leg to expire. I watch closely to see if the stock goes up or down. If the stock goes down or stays even I let the 2nd leg expire worthless and do the same for the 3rd leg.
On 11/13/15 NFLX goes up above Strike Price: I lose my stock and watch closely. I keep the $1300 premium and make $1.50 on the stock sale. Up a total of $2800. If the stock continues up I buy another 1000 shares of stock to cover 2nd leg. I have a little cushion because the 2nd leg was $7 Out-of-the-Money.
I repeat the process until the 3rd leg expires. The total profit is unknown because I don’t know how much I would make on the stock if I have to cover the 2nd and 3rd legs. If the stock only goes down, you make the total premium of $3350.
How my Triple Play Hedge played out
On Friday 11/15/15 NFLX took a big drop. The 1st Call with the Strike Price of $115 expired worthless. On Monday 11/18/15 the stock opened at $103. The Calls were way down so I decided to buy back the Calls to end the entire Triple Play Hedge. Like I said the 1st Call expired worthless. The 2nd Call was selling at $.15, I bought back for $150. The 3rd Call was selling at $.20, I bought that one back for $200. My total buy out was $350. I brought is a total of $3350 in premium and spent $350 to end the deal for a total 2 day gain of $3000.
By the end of the week NFLX was up to $124. This worked great! All Triple Play Hedges might not be so easy. Follow “Main Street beats Wall Street” and watch for more of my strategy, Triple Play Hedge. Im sure I’ll be doing many more as I find the right situation.
Remember, when selling Covered Calls as insurance, you are only protected by the amount of premium you bring in.