When the stock market causes concern for investors, many shareholders start to consider the use of puts. Significant, sometimes abrupt changes in pricing can create considerable uncertainty as to future market conditions. Uncertainty in turn leads to market volatility and the need for an effective means to hedge the risk of adverse price exposure.
Hedging investments is simply the transfer of price risk. It is accomplished by establishing equal and offsetting positions in different markets. For example, the purchase of a futures contract put can hedge a portfolio of stocks.
The easiest way to understand hedging is to consider it as insurance. When investors hedge, they are insuring themselves against an undesirable price movement in their investment. This doesn’t prevent an undesirable price movement from occurring, but if it does occur and the investor is suitably hedged, the negative impact of the movement is reduced. Examples of hedging can be seen every day. If you purchase auto insurance, you are hedging yourself against vandalism, collision damage, personal injuries, or other undesirable events
The buyer of a put option has the right to sell a futures contract at a specific price on or before the expiration date. S&P Index puts should rise in value if the index falls, depending on the amount of the index move. Any profit made on the puts could be used to offset a potential loss in the S&P portfolio.
An E-Mini S&P 500 put option gives the buyer the right to participate as the S&P 500 falls below a predetermined strike price until the option expires. The buyer of an E-Mini S&P 500 put has substantial profit potential in the event of a downturn in the S&P 500. An investor who purchased and is holding a E-Mini S&P 500 put has predetermined, limited financial risk.
Sam ZellAmerican Billionaire Businessman and Philanthropist
““The definition of a great investor is someone who starts by understanding the downside. You must make the judgement in advance as to how much downside risk you are willing to take”
Ray DalioAmerican billionaire investor, hedge fund manager, and philanthropist.
“Makes sure that the probability of the unacceptable (ie the risk of ruin) is nil”
Nassim TalebAuthor of the Black Swan
“People find insuring their house a necessity, not something to be judged against a financial strategy, but when it comes to their portfolios, because of the ways things are framed in the press, they don’t look at them in the same way.”
Paul Tudor JonesAmerican billionaire investor, hedge fund manager, and philanthropist.
“The most important rule of trading is to play great defence, not great offense”
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Using futures and options whether separately or in combination, can offer countless trading opportunities. The 25 strategies in this publication are not intended to provide a complete guide to every possible trading strategy, but rather a starting point. Whether this guide will provide the best strategies and follow-up steps for you will depend on your knowledge of the market, your risk-carrying ability, and your trading objectives.
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This material is conveyed as a solicitation for entering into a derivatives transaction.
This material has been prepared by a LaSalle Futures Group broker who provides research market commentary and trade recommendations as part of his or her solicitation for accounts and solicitation for trades; however, LaSalle Futures Group does not maintain a research department as defined in CFTC Rule 1.71. Past performance is not necessarily indicative of future performance. The risk of loss in trading futures contracts or commodity options can be substantial, and therefore investors should understand the risks involved in taking leveraged positions and must assume responsibility for the risks associated with such investments and for their results. OPTION SELLING INVOLVES UNLIMITED RISK OF LOSS. Trade recommendations and profit/loss calculations may not include commissions and fees. Please consult your broker for details based on your trading arrangement and commission setup.
RISK DISCLOSURE: Futures Trading involves substantial risk of loss, is not for every trader, and only risk capital should be used. Margins are subject to change. Past performance is not indicative of future results. An investor could potentially lose all or more than the initial investment. News may already be factored into market price.
Options Disclaimer: Transactions in options carry a high degree of risk. Purchasers and sellers of options should familiarize themselves with the type of option (i.e., put or call) which they contemplate trading and the associated risks. You should calculate the extent to which the value of the options must increase for your position to become profitable, taking into account the premium and all transaction costs. The purchaser of options may offset or exercise the options or allow the options to expire. The exercise of an option results either in a cash settlement or in the purchaser acquiring or delivering the underlying interest. If the option is on a future, the purchaser will acquire a futures position with associated liabilities for margin (see the section on Futures above). If the purchased options expire worthless, you will suffer a total loss of your investment which will consist of the option premium plus transaction costs. If you are contemplating purchasing deep-out-of-the-money options, you should be aware that the chance of such options becoming profitable ordinarily is remote. Selling (“writing” or “granting”) an option generally entails considerably greater risk then purchasing options. Although the premium received by the seller is fixed, the seller may sustain a loss well in excess of that amount. The seller will be liable for additional margin to maintain the position if the market moves unfavorably. The seller will also be exposed to the risk of the purchaser exercising the option and the seller will be obligated to either settle the option in cash or to acquire or deliver the underlying interest. If the option is on a future, the seller will acquire a position in a future with associated liabilities for margin (see the section on Futures above). If the option is “covered” by the seller holding a corresponding position in the underlying interest or a future or another option, the risk may be reduced. If the option is not covered, the risk of loss can be unlimited. Certain exchanges in some jurisdictions permit deferred payment of the option premium, exposing the purchaser to liability for margin payments not exceeding the amount of the premium. The purchaser is still subject to the risk of losing the premium and transaction costs. When the option is exercised or expires, the purchaser is responsible for any unpaid premium outstanding at that time.