In previous posts, I’ve discussed buying insurance when your option portfolio is subject to losses resulting from a significant market move.
As a seller of credit spreads (the two halves of an iron condor position), I often own such insurance.
I thought this would be a good time to mention that those insurance strategies can be used as a standalone position with positive gamma.In other words, if you want to own a position that earns a profit when the market makes a quick and large move, either of those insurance positions can work for you.
The first is a simple plan: buy puts and calls.I am not a big fan of this play. Primarily because it costs too much (for my comfort).But, if the unexpected big move does occur, the payoff can be substantial.
The play I prefer is the credit spread, with extras.The initial cost is low and if nothing wonderful happens, the final cost will depend on how you handle the leftover part of the trade (when your long options expire).You can find more information in the example discussed earlier.
That example:
Sell 3 (or a multiple thereof) RUT Apt 360/370 put spreads
Buy 1 (for each 3 spreads above) RUT Mar 360 puts
If the market heads lower, you own naked long puts and that’swhy profits are available when the market drops.
addendum 7:15 AM 2/18/2009
If this appeals to you, be certain to choose options that give you a chance to make some money.The two major factors to consider are: the strike prices and the ratio of extra longs to short spreads.
When using this idea to insure your portfolio, it’s easier to choose strikes because you want the potential profit from this position to occur before the underlying reaches a price at which losses become unacceptable.
