Free Portfolio Insurance

Protect Your Trade With Free Insurance

Note From The PitMaster:
This strategy combines the best features of Strategy #3 (buying underpriced options to protect your position) and Strategy #10 (covered call writing). With this strategy, you buy out-of-the-money put options to protect your position against a market crash. In addition, you sell out-of-the-money calls to pay for the puts.

Consider the following:
Suppose you own one OJ contract that is trading at 75. You like this market because you feel it has good upside potential. However, you are nervous about the possibility that the market might undergo a large correction. You would feel much more relaxed and confident if you could protect your holdings against this type of risk.

Here's how you can get free insurance:

	Look for underpriced out-of-the-money OJ put options (the option premium will be less than the fair value). If you can't find any that are underpriced, it doesn't matter, just pick a put option that is one or two strikes out-of-the-money.
	Next, look for overpriced out-of-the-money OJ call options (the option premium will be more than the fair value). If you can't find any that are overpriced, again it doesn't matter, just pick a call option that is one or two strikes out-of-the money.
	Continuing with our example above, you own one OJ futures that is currently trading at around 75. So, here's what you do: Buy one 70 put option and sell one 80 call option. In essence, you are buying insurance (puts) and writing covered calls to pay for it. This gives you free insurance that will protect your position in the event of another large market correction against your standing futures position.
	If the price of your futures moves up above 80 and the call option you sold is exercised, then you have to be willing to sell your OJ at that price. But, as mentioned in Strategy #10 (covered call writing), if this happens, it means you have a small but tidy little profit. In addition, you can always buy the futures back again on a pullback.
	But the main benefit here is, if the market crashes, you won't get burned.