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2020issue C0444-45

Scenario-first SPY put hedge: butterfly versus long put

A protective put on a diversified book can sit on a broad-market fund, but only after the hedge names a decline size and a horizon. A historical case spent nearly the same premium on a long put and a put butterfly, and the payoff that matched an ordinary pullback was not the payoff that matched a crash.

  • Hedging a stock or fund book is one of three core option uses, together with expressing a market view and generating income.
  • A protective put can be an index overlay, but the overlay should name a decline size and a horizon before any premium is spent.
  • With nearly equal hedge budget, the butterfly spread paid more between roughly SPY 293 and 316, while the long put kept gaining if the decline ran below 293.
  • Neither structure is singled out as correct. The choice follows the feared scenario, the capital allocated to the protective put, and the payoff versus risk tradeoff.
Entries in this reading3 entries
Butterfly spread3 readingsProtective put11 readingsCurrent trackLong put26 readings

Hedging sits beside view and income

Hedging a stock or exchange-traded-fund book is treated as one of three core option uses, together with expressing a market view and generating income.

A protective put can sit on a broad-market index or index fund rather than on each individual holding. That index overlay is a long option position meant to bound downside on an existing stock or fund book without selling the holdings.

Name the decline and the horizon first

Before a protective put is placed, the intended hedge should name a decline size and a horizon. The overlay can then be built for that feared scenario rather than for an unspecified unease.

The cash premium committed to the overlay is the hedge budget. Once that budget is set, the same outlay can be spent on more than one structure so the payoff band can be compared with the scenario that was named.

A worked case after a sharp rise

A worked case after a sharp S&P 500 rise from early October 2019 into mid-January 2020 compared two March 31 SPY overlays. Both were aimed at a retracement toward the 286 to 303 area.

The long put example bought two SPY March 31 324 puts at 7.98, for a cash outlay of 1596. A long put is a single-strike put whose expiration payoff keeps increasing as the underlying falls.

The butterfly spread example bought five March 31 319 puts at 6.26, sold ten 293 puts at 1.82, and bought five 267 puts at 0.55, for a cost of about 1585. A put butterfly buys a higher strike, sells twice as many of a middle strike, and buys a lower strike so payoff concentrates in a target band.

Equal hedge budget, different payoff bands

With nearly equal premium, the butterfly offered more payoff between roughly SPY 293 and 316. Below 293 the butterfly payoff dropped sharply and the long put payoff continued to rise.

In that comparison, a hedge aimed at an ordinary pullback favored the butterfly spread, while a hedge aimed at a market crash favored the long put.

Neither structure is singled out as correct. The choice follows the scenario being hedged, the capital allocated to the protective put, and the resulting payoff versus risk tradeoff.

Educational research material, not investment advice. Historical source context does not establish present-day performance.
22 of 22 in the Long put track
1986Track finished · Next track: Mean reversionA futures fade as one range, order, and secrecy procedure72 readings
All readings on this track · 22 readings
  1. 1984A long silver put as a prepaid loss cap
  2. 1984Spectral window gates for index long puts
  3. 1990Breadth nonconfirmation as the gate for a volume fade and long-put case
  4. 2002Volatility-first construction for a bearish put or debit
  5. 2002Name the regime and the season before choosing a long put
  6. 2005Critique of put spreads versus outright long puts
  7. 2007Sector put hedges, automatic exercise, and pin risk
  8. 2008Margin shock, defined-debit options, and selective premium
  9. 2008Ranking in-the-money puts by breakeven rather than cheapest premium
  10. 2012Evaluating long-put moneyness when implied volatility shifts
  11. 2012Sizing a long butterfly for early assignment and a long option for gamma
  12. 2013Gold after the April break: option-spread vehicles and a long-put hedge
  13. 2014A defined-risk option case for the mid-February to mid-July energy window
  14. 2014Long put versus vertical debit spread on a Treasury ETF
  15. 2015Defined debit call spread on a health-insurer worksheet
  16. 2015Overbought technology index: a long put via an inverse proxy
  17. 2018Replace futures stops with short-dated long puts
  18. 2018Constructing short-dated long puts around weekly expiration
  19. 2018Four decisions before a portfolio protective put
  20. 2018Incremental producer hedging with puts and risk reversals
  21. 2019Put butterfly versus long put in a volatility spike
  22. 2020Scenario-first SPY put hedge: butterfly versus long put
By fieldOptions and volatility193 readingsBy year202089 readings
All 26 readings tagged Long put
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