Investing with options: hedging the Nasdaq 100

Important note: the strategies and examples provided in this article are purely for educational purposes. They are intended to assist in shaping your thought process and should not be replicated or implemented without careful consideration. Every investor or trader must conduct their own due diligence and take into account their unique financial situation, risk tolerance, and investment objectives before making any decisions. Remember, investing in the stock market carries risk, and it's crucial to make informed decisions.

Trade setups analysis

Long puts on the QQQ etf

Underlying Asset: Invesco QQQ Trust, Series 1 (QQQ)

• Option Type: Long Put
• Expiration Date: 15-Dec-2023
• Strike Price: 405 USD
• Quantity: 3 Contracts
• Net Premium Paid: 4,428.00 USD
• Delta: -0.8671

Analysis of the Long Puts: 

Hedging Strategy:

• Maximum Risk: The total premium paid for the puts, which is $4,428.
• Maximum Profit: Theoretically significant since the profit increases as QQQ falls below the strike price, with the maximum profit occurring if QQQ were to fall to $0 (not a realistic scenario).
•  Break-Even Point: The strike price minus the net premium paid per share, which is calculated as the total premium divided by the number of contracts and the contract multiplier.

Hedging Calculation:

• Determine the amount to protect: $110,000 * 95% = $104,500.
• Capital at risk: $110,000 - $104,500 = $5,500.
• Evaluate the cost-effectiveness: The premium paid for the puts ($4,428) is slightly less than the capital at risk ($5,500).
  Let's calculate the break-even point for these long puts and assess whether this setup could be a feasible hedging strategy for the portfolio.
• The break-even point for the long put options on the QQQ is $390.24 per share. This means that for the puts to start being profitable, QQQ's price would need to fall below $390.24 by the expiration date.

Feasibility of the Hedging Strategy:

• Maximum Risk: The total premium paid for the puts is $4,428, which is less than the capital at risk ($5,500) in the portfolio.
• Break-Even Point: The break-even point is slightly lower than the current QQQ price of $390.34, which means the puts will start gaining intrinsic value if QQQ drops just slightly from its current level.
• Hedging Effectiveness: The maximum profit is theoretically large if QQQ drops significantly, potentially providing substantial downside protection. However, this is capped by the reality that QQQ is unlikely to fall to $0, and profits are not linear due to the option's Delta.
• Portfolio Protection: The premium is close to the capital at risk; thus, the puts could serve as a partial hedge. If QQQ were to decline below the break-even point, the increase in the value of the puts could offset some of the portfolio losses.
• The break-even point is close to the current price, making it a sensitive hedge that could respond to even small decreases in the QQQ price.
  
  However, as with any options strategy, there are trade-offs. The time decay (Theta) will erode the value of these options as the expiration date approaches, especially if QQQ does not move below the break-even point. Additionally, the Delta indicates that the option price will move approximately $0.8671 for every $1 move in QQQ, which reflects high sensitivity to price changes in the underlying asset.

In conclusion, while the long puts on the QQQ do not offer a perfect hedge due to the premium paid, they could be a key component of a hedging strategy designed to protect the gains in your portfolio. This approach would be particularly effective if you anticipate a moderate to significant drop in the QQQ price before the expiration date.

Your insights matter to us. Rate this article.

Debit put spread on the NDX

Underlying Asset: Nasdaq 100 Index (NDX)

• Strategy: Put Debit Spread
• Buy Put Strike: 16100 USD
• Sell Put Strike: 16000 USD
• Expiration Date: 15-Dec-2023
• Quantity: 1 Contract (for both buy and sell legs)
• Net Premium Paid: 4,340.00 USD
• Delta of Bought Put: -0.5029
• Delta of Sold Put: -0.4367
  

Analysis of the Put Debit Spread:

Hedging Strategy:

• Maximum Risk: The net premium paid, which is $4,340.00.
• Maximum Profit: The difference between the strike prices minus the net premium paid.
• Break-Even Point: The bought put strike minus the net premium paid per share.

Hedging Calculation:

• Determine the amount to protect: $110,000 * 95% = $104,500.
• Capital at risk: $110,000 - $104,500 = $5,500.
• Evaluate the cost-effectiveness: The premium paid for the spread is less than the capital at risk.
• Profit/Loss Scenarios: If the NDX falls below the break-even point, the spread starts to profit, which can offset portfolio losses.
• Let’s calculate the maximum profit for this spread and assess whether this setup is a feasible hedging strategy for the portfolio.
• The put debit spread on the NDX has a maximum profit of $5,660 and a break-even point at an NDX price of $16,056.60.
  

Feasibility of the Hedging Strategy:

• Maximum Risk: The maximum risk is the net premium paid, which is $4,340.
• Maximum Profit: The maximum profit is $5,660, which is slightly more than the capital at risk ($5,500) of the portfolio.
• Break-Even Point: The position becomes profitable if NDX falls below $16,056.60, which is relatively close to the current NDX price of $16,037.16.
  

For this put debit spread to be a viable hedging option, the maximum profit would ideally be at least equal to the capital at risk, which it is in this case. The strategy could provide coverage for a moderate drop in the NDX, with the potential to slightly exceed the capital at risk if the NDX falls significantly below the break-even point.

As a hedge, it offers a decent balance between risk (the premium paid) and potential reward (maximum profit). However, the actual effectiveness of the hedge depends on the movement of the NDX. If the index remains above the break-even point, the hedge would not be profitable, but the maximum loss would still be capped at the premium paid.

The deltas of the options indicate the sensitivity of the option prices to changes in the underlying NDX. Since the absolute values of the deltas are close to each other, this spread is less sensitive to small changes in the NDX price compared to a single long put option, but it provides a strong potential for profit if a significant drop occurs.

In summary, this NDX put debit spread seems to be a more suitable hedging strategy compared to the single long put options previously discussed. It provides a reasonable balance between cost and the level of protection for the portfolio, assuming the NDX moves below the break-even point.

Your insights matter to us. Rate this article.

Conclusion and comparative analysis

Upon analyzing the two hedging strategies, we can draw objective conclusions based on the capital at risk and the simulations performed. The following table incorporates these crucial financial implications:

Capital at Risk Calculations:

Simulations:

Final words:

Did this article meet your expectations? Your feedback counts! Please rate & review.

Related articles:

• Technical analysis Nvidia AMD TSM Intel ASML
• Technical analysis Nasdaq 100 SP 500 bullish thanksgiving market
   
• From zero to hero - buying options
• From zero to hero - selling options
• From zero to hero - option strategies
  
  
• Why options strategies belong in every traders toolbox
• Understanding and calculating the expected move of a stock etf index
   
• Understanding Delta - a key guide for Investors and Traders - part 1
• Understanding Delta - a key guide for Investors and Traders - part 2
   
• Trading 0DTEs - get your feet wet - without drowning - part 1
• Trading 0DTEs - get your feet wet - without drowning - part 2

Previous "Investing with options" articles: 

• 17 Nov 2023: Investing with options - Nvidia - pre-earnings
• 10 Nov 2023: Investing with options - AdYen - post investor day
• 31 Oct 2023: Investing with options - Novo Nordisk earnings
• 31 Oct 2023: Investing with options - Apple earnings
• 24 Oct 2023: Investing with options - Amazon earnings
• 24 Oct 2023: Investing with options - Meta Platforms earnings
• 23 Oct 2023: Investing with options - Alphabet earnings
• 20 Oct 2023: Investing with options - Microsoft earnings
• 18 Oct 2023: Investing with options - Tesla earnings
• 17 Oct 2023: Investing with options - long bonds - TLT