How to trade Options for beginners: Protective Put via moomoo app

How to trade Options for beginners: Protective Put via moomoo app

In this article, we will be taking a look at the Protective Put strategy that you can use to protect your bullish (long) position on a particular stock using a put option. Previously, the covered call strategy was written here.

This post was originally posted here. The writer, Everest Fortune Group, is an Award-Winning Research House and Singapore FinTech Company.

Who is it for?

  • Investors who are bullish on a particular stock
  • At the same time, the investor would like to “buy” insurance to protect against potential downside.

How does it work?

Let’s take a look at our hypothetical character, Jon. Jon is looking at the Netflix chart and thinking if there are any opportunities to purchase some shares.

As he analyses Netflix (NFLX), he realizes that it is on a strong support area around the 600 region.

There’s an ascending support line.

There’s also a strong overlap support area.

With this bias in mind, he then decides to buy 100 shares of Netflix at a price of $605.

Now, Jon knows that the 600 area is a strong area of support. However, according to his analysis, if price breaks this level, it could drop by quite a bit. With that in mind, he figures that he should protect his position by purchasing a put option.

Now, the key questions he needs to ask himself are:

  • How many put options does he need to purchase to protect his 100 shares of Netflix?
  • What should be the strike price of his put option?
  • What should be the expiry date of his put option?

Let us explore these questions and see how we can address them.

“How many put options does he need to purchase to protect his 100 shares of Netflix?”

In this case, since Jon has 100 shares of Netflix and 1 put option represents 100 shares, Jon can purchase a single put option to hedge against a potential drop in price of his 100 shares of Netflix.

“What should be the strike price of his put option?”

Having purchased Netflix price at $605, what should be the strike price of the put option Jon is about to buy?

One approach to deciding his put option’s strike price is to factor in where the key support area he thinks Netflix should hold above. As seen in our example above, there is a strong support area at the $600 area. So theoretically, Jon would hope that there’s a high probability that price would hold above this level (and bounce up).

However, if price breaks this $600 level, then it might drop quite strongly and he wants to protect his position against that.

To achieve this, since $600 is his key support level, he would buy 1 put option with a strike price of $600. That means – if price were to break this $600 level, the put option would essentially be “protecting” his Netflix position, hence the name “protective put”.

If Jon wanted to protect his entire long position at $605, he could buy a put option with a strike price of $605 (instead of $600). This variation of the protective put option is then called a “Married put”.

“What should be the expiry date of his put option?”

To decide this, Jon decides to use moomoo’s simple date estimation tool:

Using it, he sees that price might make a bounce up to recent highs in the 700 area roughly over the next 66 days. This is, of course, just an estimation based on how he hopes price might behave.

With this in mind, he can then get a better gauge on the expiry date of his put option. Instead of paying more premiums for an option that expires further into the future, he now selects the put options that expires on the 18th of February 2022 (roughly 66 days from 14th of December 2021).

Buying a put with a strike price of $600 expiring in roughly 66 days on 18th of February would cost $35.05 * 100 = $3,505 as seen in the picture below.

How could this play out?

Let’s look at some scenarios on how this trade could play out.

If Netflix dropped to $400:

  • Jon’s 100 shares of Netflix would be worth $40,000 instead of the $60,500 he bought it at.Without a protective put in place, he would have lost $20,500.
    With a protective put in place, he would have lost $500 (since the protective put makes $20,000 with a strike price of $600) and also lose the premium he paid at $3,505. Totalling $4,005.

If Netflix shot up to $800:

  • Jon’s 100 shares of Netflix would be worth $80,000 from the $60,500 he bought.Without a protective put in place, he would have made $19,500
    With a protective put in place, he would have made $19,500 – $3,505 (option premium paid) resulting in $15,995. He loses the option premium because the put option would expire worthless.

We can see how a protective put does really well in protecting the downside of a trading strategy.

This month via moomoo trading platform they have launched a $0 commission* Options trading. Click here to find out how you can collect all 6 options-related cards to get double the rewards! This promotion ends on 31 Dec 2021.​

The moomoo trading platform provides a really comprehensive and easy to use options pricing table which you can easily see not only the bid/ask prices, but other very important option greeks that if you combined with the support/resistance strategy I’ve shared, could help you trade even better.

All images in this article are for illustration only.

This article was written by Everest Fortune Group in collaboration with FUTU SG.

Disclaimer: This written article should be taken as of a general nature and should not be taken to constitute as financial or trading advice, guidance or recommendations with regards to any trades, investments or decisions in any matter. It is your duty to approach a professional advisor If you are relying on any part of this article. Any investment or trade is solely at your own risk and you will not hold Everest Fortune Group Pte Ltd, FUTU SG or Investing Note Pte Ltd liable whatsoever for any losses you might incur.

Once again, this article is a guest post and was originally posted on Everest Fortune Group‘s profile on InvestingNote. 


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