many traders don't but leap puts for protection because they think it is expensive and if the stock goes up they loose a lot of money. following through the example below to see how that thinking is incorrect.
Adjusting Your DITM Leap Put with Increasing Stock Price
The example below was done using option calculator from Ivolatility.
Starting data: Iwm = 62.8 date 2/27/2010
Purchasing Jan12-70 strike leap put (696 dte) and selling 90 day covered calls for income.
696 dte – bto 70 leap put for 13.3
net invested = 62.8 + 13.3 = 76.1
at risk = 76.1 – 70 = 6.1 or 6.1/70 or 8.7%
at covered call expiration stock increases to 70 same price as leap put strike
most traders would think this is a bad scenario for someone with protective puts, ie. They feel if underlying increases they are losing money. Well let's see.
602 dte – stock at 70 – stc leap put all time value = 9.06 and then bto the 75 strike leap put at 12.10. you increased your invested by (12.10-9.06) = 3.04.
your new net invested = 76.1 + 3.04 or 79.14 but look now
at risk = 79.14 – 75 = 4.14 or 4.14/75 = 5.5%
512 dte – stock at 75 – stc leap put all time value = 8.96 and then
bto the 80 strike leap put at 11.98. you increased your invested
by (11.98-8.96) = 3.02.
your new net invested = 79.14 + 3.02 or 82.16 but look now
at risk = 82.16 – 80 = 2.16 or 2.16/80 = 2.7%
422 dte – stock at 80 – stc leap put all time value = 8.69
bto the 85 strike leap put at 11.69. you increased your invested
by (11.69-8.69) = 3.0
your new net invested = 82.16 + 3.0 or 85.16 but look now
at risk = 85.16 – 85 = 0.16 or 0.16/85 = 0.0019% essentially no risk in the position.
332 dte – stock at 85 – stc leap put all time value = 8.22
bto the 90 strike leap put at 11.22. you increased your invested
by (11.22-8.22) = 3.0
your new net invested = 85.16 + 3.0 = 88.16 but look now
at risk = 88.16 – 90 = minus 1.84. ie you have NO risk in this trade and you still have 332 days to continue selling covered calls and collecting premium knowing you can't lose money at all.
I usually look to roll out the leap put to a further out leap with 1 year to expiration.
As you can see owning a leap put with an increasing stock price is not a bad situation at all but a good one if you are selling premiums.
drjoe
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