≈ Paper Trading Puts≈
Say you want to buy a protective put. Maybe you’re purchasing it on a single position, or perhaps you’re acquiring it on an Index ETF like SPY to protect your portfolio. In either case, you must necessarily decide which strike price and expiration to use.
When it comes to strike selection, I like to use an insurance analogy-the higher your deductible, the cheaper your premium. In the case of puts, your deductible is the distance OTM. If you buy a put that’s 5% OTM, then you have a low deductible, but the premium will be higher. If you buy a put that’s 10% OTM, then you have a high deductible, and the premium will be lower.
In the Bear Market Survival Guide, we suggest buying puts that are 10% OTM. You can move it closer or further away, however, depending on your preference.
Pinning down which expiration to use depends in large part on the desired length of protection. Are you buying insurance for a specific event, such as earnings? Or are you buying it to own for months on end? In the latter case, I care much more about time decay and thus favor buying long-term protection. In the Bear Market Survival Guide, we suggest using one-year puts.
The best way to understand how protection works is to try it in a paper account. Consider this your nudge to do so.
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Originally published at https://tackletrading.com on July 6, 2021.