I’m a big fan of simple option strategies. Complex does not always mean better. Some people often neglect option strategies that hedge risk. This might be an investor that buys a stock and also buy a put to protect against a drop. The analogy in this case is buying insurance in which the price of the put is the insurance premium. The problem of course is that insurance costs money. The better you insure yourself (buying a put closer to the money in our example) the more you pay.
The Fence Technique
Unlike insurance, we can reduce the cost of the premium. How so? Consider a stock trading at $100. Suppose we buy a protective put at a strike of 95. We could also sell a call option at a strike of 110. This would mean that we are covered if the stock falls below 95 and we would also participate in any upward move until 110 at which point the call option would be exercised. Thus, we have lowered the cost of buying the protective call by selling a 110 call. Of course this comes at the price of a maximum profit of only 10$ minus the cost of selling and buying the options. This simple technique should not be under estimated though for the solid investor who doesn’t want to take big risks.
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Dear Sir
Sir, I am jaishree from India. Can You tell me the best strategy for option selling for reducing risk in trading option. What point to sell ie., otm, itm, atm. when the price moves up sell a call/ put and vice versa. what about the expiration to exit the trade.
Thank you,
with regards
jaishree