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The Secret of Hedging in this Market

I absolutely love the timing of hedging questions.

When the market has a day like it did last week, I'll start getting emails trickling into my inbox about the best way to protect against a drop in a portfolio. Or how to repair a stock or option strategy when the market stopped being so easy.

But remember-- that is reactive trading.

When it comes to looking to protect assets and other trades, we want to be proactive in looking for hedging techniques.

In the stock and options universe, there's a variety of ways to hedge. You could short stock, get long inverse etfs, buy puts, sell calls, sell puts on inverse etfs, and so on.

But I want to tell you my absolute favorite hedge right now.

The Trade Setup

The trade I like here is the OTM Put Calendar. This is where you sell an out of the money (OTM) put in the front month option, and buy a back month option. This trade makes money on a specific set of conditions:

1. A fairly solid pullback

2. A rise in implied volatility

3. Time decay in the front month option

4. Not a market crash

The Greeks

The best thing about this is that the initial delta (directional exposure) is pretty low-- that way if the market rips higher you won't be out that much cash. You also get a good vega (vol exposure) boost if the market does pull back further. And if it stays near the strike then we get positive theta (time exposure) which is always a nice thing.

If you think the market's going to get zerohedged, then cowboy up and buy puts. But if you're looking for a prudent hedge this may be your ticket.

Confused?

Yeah, I tend to do that to newer option traders. If you want to learn all about calendars, the greeks, and trading options-- check out my video course at OptionFu.com.

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/