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We have an advantage, actually, as individual investors, to create more flexible positions – because generally, our positions are going to be a lot smaller than the hedge funds. Hedge funds have to come in with millions of dollars of stock options and purchases, and they have to negotiate with banks and other investment companies, in order to put on their trades.
On the other hand, we can go in and buy 100 shares of this, 1000 shares of that, 100 shares of this, 500 shares of that, and then hedge them with index options like the QQQs, in order to hedge our entire portfolio. Now, what’s happened to our position? Now, we have a maximum downside risk of about $400, by buying the QQQ put options for July, against these 300 shares of our stock.
It gives us a good deal of downside protection, as well as unlimited upside protection, which is what we’re looking for. Our Delta is 157, so it’s a good Delta. If the stock does move up, if all of our stocks continue to move down, then we don’t have quite as much position. On 300 shares, we may have to adjust this up a little bit. We might buy 4 contracts for 300 shares, so we can get to a position where you feel comfortable.
In other words, our maximum loss here is going to be about $583, if the stocks we picked do not move, or the QQQs do not move. If our stocks go up, we do have unlimited upside potential. Actually, if we get hit with a really bad bear market, and all of our stocks go down – our QQQ position is actually going to make money for us, and act as a hedge against our long positions in our stocks.
This is the way hedge fund managers and professional investors manage their stock positions. Just like we did with our option positions in our monthly income trades, we look at the numbers. We trade by the numbers. We take a look at our Delta. We take a look at our profit and loss over time. We are hedging our stock positions, based on our portfolio-weighed QQQs, and then purchase the number of QQQ puts, to help protect the downside of our stock position.
Let’s see, if we take that out – you can tell that if we take those QQQs out, and we did not buy those puts as protection, yes, we still have unlimited upside risk. We also have almost unlimited downside risk. I say “almost” unlimited downside risk, because the stock can’t go below zero. If our stocks do go to zero, we would have lost the maximum of our investment, which is about $13,800, in the 300 shares of these different stocks.
Hedging, as you can tell, is a very good investment. It does put a little bit of a limit on your upside profit. However, that is a price well worth paying as insurance. You also have very nice downside protection. The only thing that you have to be concerned with, at this point, is that your stock is not moving at all.
What can you do? You can do the same thing, if your stocks go down, you can do the same thing that you were going to do on each individual one of these positions. Let’s say the market just fell apart, and all of a sudden dropped a few thousand points. The QQQs went down to extreme levels. We lost about 10 to 15 points on the QQQs.
You take those profits, and you would reinvest it in another 50 shares of that, or that. You can divide it in any way that you want, but use that insurance policy that you cashed in if the market goes down, in order to purchase more stocks.
When it does go up, you’ll be in a really nice position. You’ve added shares to your position that were basically free. Because you purchased that put option to begin with, you don’t have to take any money out of your pocket, to buy additional shares of the stock.