Follow-up to Alternatives to Selling a Position

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Make sure you read the disclaimer listed in the frame of this site. Here's the TL/DR:  You are responsible for your actions, and I am not.

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Last week I wrote about a hypothetical position in PINS that was up 115% since entry.  The price when I wrote the piece was $80.54 and had a stock basis of $37.44.  Review that entry here ( https://greekgodtrading.blogspot.com/2021/02/alternatives-to-selling-position.html )

I ran the scenario that if PINS dropped below the 65d EMA and if this was your trigger to exit, that there were other alternatives to unloading the position (IF your long-term outlook in PINS was bullish).  

The idea behind the approach was to buy a at-the-money (ATM) or in-the-money (ITM) put, so if price fell, you would be protected at some level until the option expired.

The scenario bought the 18 June 75 Put, which was $9.35 per contract.  You paid $935 per contract for this protection.

Friday, 3/5, saw PINS close at $68.40, BELOW the 65d EMA.

If you were holding the $75 put, would you be protected?

Short answer:  yes, for the amount below $75.  Here's the math:

Total cost of the stock:  $3,744

Total cost of option: $935
Total cost:  Stock + Option = $4,679

Stock value @ $68.40:  $6,840

Option value @ $68.40: ($75 - $68.40) = $6.60 * 100 shares = $660

Stock and Option value @ $68.40: $660 + $6,840 = $7,500

Total Value = $7,500 - $4,697 = $2,821

Total position gain:  $2,821/$4,697 = 60.1%

I note that no matter how far down PINS drops that the gain on the position will remain at 60.1%, at least until June 18th.

If PINS moves above $75 the position will gain 1:1, as expected.

Buying insurance could have been a good approach to hold onto the stock as it closed below the 65d.  It may be still a good option (no pun intended), but realize, it will cost more because the volatility is  higher.

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So, what if you weren't a believer last weekend and now you are?  

Between last week's post and this one I've shown how to calculate the overall "Total Position Gain %" with the option in place.  Now, without proof, if you want to still employ a strategy like this, here are the insurance levels for various strikes, assuming you enter at the "ask" early Monday morning, 3/8, using the weekend option prices for the June 18th put:

Strike:  $65

Ask:  $8.80

% Return (insurance level):  40.6%

Strike:  $70

Ask:  $11.80

% Return (insurance level):  42.2%

Strike:  $75

Ask:  $14.80

% Return (insurance level):  43.6%

Strike:  $80

Ask:  $18.25

% Return (insurance level):  43.7%

From this exercise you can see that buying progressively deeper ITM puts doesn't really protect you more, and this is because the total cost of protection goes up with the put strike level. Hence, with a close at $68.40 on Friday, while you could spend more to go from the $70 strike to the $80 strike, it's not overly beneficial for the position.  Why spend more on the position than you have to?

For those of you who like to graphically see what is happening, here is the risk profile using the original $75 put strike:

Click on the image to enlarge

The graphic shows that below $75 we are completely protected (blue line), and because of variable time premium between now and June, the yellow line shows that we have greater value today than we will in June (time premium decays -- "theta" -- as we get closer to expiration).

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To offset the cost of the insurance, we can sell short-duration OTM calls that have little chance of being ITM at OE.  Last week I decided to sell the 89 strike call that expired 3/5, since PINS offers weekly options.  This allowed me to collect $0.70 per contract, taking the cost of the original stock and the put option down from $46.79 to $46.09. 

This week, because the price of PINS has dropped a significant amount, the call strike that I'm going to sell has dropped too.  Here's what I'm thinking:

Sell the $80 call that expires 3/12 for $0.31.  This will reduce the basis to $45.63, moving the "floor" of the insurance policy from 60.3% (without selling calls) UP to 64.4% (having sold calls).

 

For those of you who like to graphically see what is happening, things get a bit strange when we bring multiple option expiration dates to the table.  The spread in dates (March 12, June 18th) causes the display to get difficult to interpret.  Hence, to simplify this and show that we are covered, I'm going to display only one OE -- the nearest one -- and you can see the shape of the risk profile that we are exposed to:

Click on the image to enlarge

The take away from this graph is that we are fully protected below $75 and above $80 we cap our profits.  The protection at the $75 level lasts until June 18 and the cap at the $80 level lasts only until 3/12.  Note that on the y-axis the difference in the blue line is $500, which is the spread between $75 and $80 * 100 shares, which is what we expect.

If it appears that PINS will be above $80 on 3/12 (or before) I can roll the call upward (higher strike) and out in time, perhaps for a cost, perhaps for a credit.  Depends on how fast we move towards $80 (if we do).

So, we'll continue to watch this trade and see what PINS does.

 Please do not hesitate to ask questions.

Regards,

pgd