• Trading 101: Protective Puts

    by  • June 14, 2013 10:08 am • Trading 101 with Peter Bryans • 0 Comments

    On Tuesday, I ran-through one of the more common income-generating strategies that involves selling calls against a stock that one owns. This covered call strategy, also known as a “buy-write”, is used quite frequently in the options world. Another way to use options in your trading and/or investing is to purchase what are known as protective puts. This is certainly one of the more common hedging strategies used on Wall Street and is rather straightforward.

    As the name implies, a protective put is purchased in order to hedge, or protect, one’s long stock position. Remember, a put allows the option holder (the one who purchased the premium), to sell 100 shares of the underlying at the specified strike price at, or before, the expiration date. The option seller must buy the shares, at the specified strike price, once they are put to them. Protective puts are a great way to lock in some profits, and assure that even if your stock plummets after adding up all those gains, you can still get out at a specified price. I’ll show an example with a stock where I believe a big block of protective puts was purchased by investors looking to hold onto their gains.

    In the first 3 months of 2013, Consumer Staples were one of the leading sectors to start the year. Kimberly-Clark (KMB) falls into this category, and is a consumer goods firm that specializes in personal care items. This large cap firm is a well-established company that has had a huge run in 2013. In fact, at its recent high of $106.51, KMB was up as much as 26%. KMB actually closed yesterday at $97.57 (all of this data is as of the close on 6/13/13).

    Take a look at the below graph. What this represents, is all bought-to-open (buyer initiated) option activity as well as sell-to-open (seller initiated) option activity for the KMB June 95-strike put. On 4/22/13, you can see there was a large amount of volume that went off at the 95-strike put, and that this volume was bought-to-open. If you look at the current open interest for KMB featured in the next graph, notice how peak put open interest still resides at this 95-strike.

    In all likelihood, this was a block of protective puts, purchased so that those who had achieved gains in KMB this year could hedge their investments. On the chart of KMB (below), I have marked (with the vertical line) where KMB was trading on 4/22/13—just north of $106. Also, note the big volume bars below price. It is very possible that these huge buying bars, before 4/22, were signs of accumulation from large institutions. They bought in right ahead of the huge run that KMB made, and wisely decided to purchase some downside protection. To be sure, there’s no telling if these were the same buyers that got in ahead of the big move in KMB. There’s also no way to be certain that these were indeed protective puts—they could even be bearish bets that the stock was set to move below $95 by June expiration all the way back in April. However, I believe that it makes the most sense that with a stock such as KMB, which is a common long-term holding for many buy and hold investors, that the buyer of these puts was already long the stock.

    (chart courtesy of eSignal)

    I always like to reiterate the importance of understanding the numerous ways to play options, and how complex this market can be. Covered calls, protective puts, and iron butterflies are all different types of trades with different strategies and outlooks. I firmly believe that when trading options, the more you familiarize yourself with these concepts, the more your trading will benefit.

    About

    Peter Bryans joined the Schaeffer's Investment Research trading team as a Trader in April, 2012. A graduate of the Fisher College of Business at The Ohio State University -- where he concentrated in Finance -- Peter previously held internships with an insurance broker and a wealth-management firm. In his current role, Peter trades a variety of our real-time option services and also hosts our "Options Apprentice" weekly webinar presentations.

    http://www.schaeffersresearch.com

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