How to choose a strike price on a protective put?

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redstar
Posts: 97
Joined: Thu Jul 13, 2017 11:15 pm

How to choose a strike price on a protective put?

Post by redstar »

I'm trying to learn more about options, and I'm also considering buying some, but I'm having a hard time figuring out what strike price to choose. I would appreciate some advice from those on this forum who have evaluated options previously.

My fiance will receive some restricted stock units of MSFT on February 15th, and the stock is currently trading near $165. I'm considering buying some put options to protect against losses until she receives and sells the stock after 2/15 to diversify (likely on Tuesday 2/18). Note that there is both an earnings and ex-dividend date between now and 2/15.

The first expiration date after 2/18 would be 2/21. Here are some quotes for puts on 2/21:
Strike 140: $0.21/share
Strike 145: $0.35/share
Strike 150: $0.62/share
Strike 155: $1.23/share
Strike 160: $2.36/share
Strike 165: $4.35/share

How would one go about choosing a strike price? Here are some of the things I considered:
1) Buy at the money and lock in existing prices.
2) Find the largest drawdown I was comfortable with and buy a put there. Let's say that was 10%, then I might buy a $150 strike price.
3) There must be some smarter analysis here that involves the expected value of drawdowns of various sizes. I see things like the greeks, implied volatility, etc, but I don't know what to optimize for. However, maybe I should just ignore that because the market has already priced all of that in (as these options seem fairly liquid).

And of course 4) Don't worry about it, don't mess with options at all. I may not end up buying any puts, but I would still appreciate the discussion if someone were considering something like this.
inbox788
Posts: 7606
Joined: Thu Mar 15, 2012 5:24 pm

Re: How to choose a strike price on a protective put?

Post by inbox788 »

How much are 165 calls? I expect Microsoft will be at 175 after earnings, but what do I know? I'm just another BH.

IMO options market in something as liquid as MSFT is as efficient as the stock, so buy what you want at the market price.

Besides figuring out what you want to insure, you have to make sure you're not violating any company policies or worse, and then they'll be tax issues, so the easiest path is to just go with the flow.
Shallowpockets
Posts: 1683
Joined: Fri Nov 20, 2015 10:26 am

Re: How to choose a strike price on a protective put?

Post by Shallowpockets »

Your fiancé does not have the stock yet.
If you buy the put and it expires you are out the money.
If you want it to exercise then you will have to let the broker know. Such as a strike if 165 and it drops to 155 and then you want to “put” it to the seller of your put. To do this I think you will need to have the stock in hand. So possession of the MSFT will be necessary. Probably in the same brokerage.
The price of your put would go up if the price of the stock dropped and you can make money that way. However it sounds like you are using it for insurance. In a short term.
This seems all very speculative for you.
MSFT is a leading stock. Would you want to sell it if it dropped by below the strike price? It only needs to be 1 cent below to exercise. Except your cost is now the MSFT strike price plus the cost of the option. Ideally you need the stock price to go below the strike price by at least the amount of the option.

I would never do this. Better to wait and take possession of the stock and sell a covered call. Much safer.

FYI. Options are traded as contracts and there are 100 shares in 1 contract. How much is your fiancé getting?
SovereignInvestor
Posts: 597
Joined: Mon Aug 20, 2018 4:41 pm

Re: How to choose a strike price on a protective put?

Post by SovereignInvestor »

Shallowpockets wrote: Thu Jan 16, 2020 5:11 pm Your fiancé does not have the stock yet.
If you buy the put and it expires you are out the money.
If you want it to exercise then you will have to let the broker know. Such as a strike if 165 and it drops to 155 and then you want to “put” it to the seller of your put. To do this I think you will need to have the stock in hand. So possession of the MSFT will be necessary. Probably in the same brokerage.
The price of your put would go up if the price of the stock dropped and you can make money that way. However it sounds like you are using it for insurance. In a short term.
This seems all very speculative for you.
MSFT is a leading stock. Would you want to sell it if it dropped by below the strike price? It only needs to be 1 cent below to exercise. Except your cost is now the MSFT strike price plus the cost of the option. Ideally you need the stock price to go below the strike price by at least the amount of the option.

I would never do this. Better to wait and take possession of the stock and sell a covered call. Much safer.

FYI. Options are traded as contracts and there are 100 shares in 1 contract. How much is your fiancé getting?
OP can just pick a expiration after getting the stock like they suggested. How is there risk beyond the price in premium ?


Buying put is more tax efficient than selling Covered call
jdilla1107
Posts: 849
Joined: Sun Jun 24, 2012 8:31 pm

Re: How to choose a strike price on a protective put?

Post by jdilla1107 »

Note that doing this violates many corporate employment agreements and stock plans. Especially if your finance is any sort of executive.
alex_686
Posts: 6848
Joined: Mon Feb 09, 2015 2:39 pm

Re: How to choose a strike price on a protective put?

Post by alex_686 »

I do this professional. One can learn the greeks and get into the math.

I will suggest that any near term options that are not “deep out the money” and have decent volume/ outstanding contracts are fairly priced. If so, go with you gut in term of loss aversion. Sane as figuring out the deductible on your car insurance.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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