Yesterday, I mentioned that I was considering buying a put spread or selling a call spread on SH to hedge some of my market exposure. Instead, I spent a little more money and have deeper coverage if the markets continue to slide. While IWM was trading at $78.05, I bought to open two IWM January $80 puts for $4.00 each and paid $800.76 including commission.
The original plan would’ve paid off sooner, but if it went against me, the put or call spreads would’ve become big losses quickly. By going long with two January $80 puts, which partially covers the three November $82 puts I’ll be assigned on Friday after the close, I cut my overall exposure much more and can sell them for a smaller loss on a reversal in the market.
I chose to buy in-the-money puts to reduce the amount of time value I was paying for. (I prefer to sell it, not buy it.) While I forked out $4.00 per share, only $2.05 was extrinsic value (out-of-the-money, aka time value) and $1.95 was intrinsic value (in-the-money). I see the extrinsic value as what I stand to lose, both on the way down and the way up. With $1.95 in intrinsic value, these puts will still be worth $1.95 when the contracts expire if IWM stays flat. If IWM falls, I don’t move to a profit on these puts until it has fallen another $2.05 (not counting a likely increase in the volatility input). If IWM rallies, I’ll have some time value cushion until expiration (I’ll also lose some as the volatility portion of the formula decreases), but by that final Friday, the $2.05 of extrinsic value will be completely gone. All of the intrinsic value might be gone, but I will have gained back on my IWM shares that I am not dumping yet. In other words, on a rally, I could lose completely on the long puts, but will gain on my shares I still own.
Since I don’t like to buy time value, I only bought two puts. That brought my account down to around 72% invested and will take some of the pain away if the bears maintain control. If stocks turn around, the $800 of insurance should be much less than I make from everything else gaining. I plan to sell these puts sometime along the course of the next nine and a half weeks. Maybe I’ll be able to profit from them and then ride IWM higher again. By the end of the day, I was already sitting on a paper profit since the drop in small caps came so quickly/sharply this afternoon.
I might still sell some put spreads or buy call spreads on SH or another inverse ETF. Then again, I might just buy more puts on IWM or another index ETF. The way the selling has been, it doesn’t look like we’re near a bottom yet. (Hint Mr. Market, that’s your cue to rally.) The SPX is down 8% from its highs. 10% surely looks like it is within reach, if not 15%. I want to be sure to have plenty of cash available to pile in when we get the next catalyst that reverses sentiment.
Today was an interesting equity sell-off. IWM lost 1.75%. SPY and DIA both lost 1.35%. Long-term bonds, as seen through the ETF TLT, barely moved higher. It means either that stocks are close to bottoming or that bonds will bump higher tomorrow or Friday. My TLT November call spread is only 50 cents out of the money with two days remaining and could easily shift to being in the money within minutes after the open if fear really takes hold. If TLT doesn’t move past $127, I’ll see a quick $460 of time value move in my favor. GLD only moved 0.02% higher. That’s not showing any signs of a real asset re-allocation yet.