A Measure of Protection

Buy this DIA Put Hedge

By Bryan Bottarelli
Tuesday, January 29, 2008 11:08 AM EST
Tue, 29 Jan 2008 16:08:00 GMT

*PROTECTIVE PUT PLAY: Buy the DIA February 120 Puts (DAW NP) at or under $1.40, good for the day. Do not place a stop loss at this time, as we want this position to protect us against any intra-day volatility tomorrow.

Dear Bottarelli Research Member,

As of this morning, we have three call positions and no put positions: AAPL February 135 Calls (APV BG), ADM March 45 Calls (ADM CI), and FRE February 35 Calls (FRE BG). Now, this current ledger will pay off handsomely if the markets embrace tomorrow’s Fed announcement and engage in a strong rally. But if the markets should fall on tomorrow, we could be exposed. Therefore, I’d like to establish a protective put position right now using the Dow Diamonds (DIA – AMEX).

DIA

If you’re a Bottarelli Research Small Cap member, then you know that we’ve already used DIA put hedges like this to gain 62% in August of 2007, 40% in December of 2007, and a whopping 225% in January of 2008. Now, when we’re faced with three upside call positions and a critical Fed meeting looming on the horizon, it’s prudent to establish a DIA protective put position to act as an insurance policy. The thinking here is to use a small amount of capital to protect your three upside call positions. If the markets rally tomorrow, you’ll lose money on this protective put position — but these losses will be more than absorbed by the gains of your calls. And on the flipside, if the markets fall tomorrow, the gains from your new DIA put will help off-set any intra-day losses that you see on your calls. Given this scenario, let’s be safe and establish this DIA protective put position now!

PLAY: Buy the DIA February 120 Puts (DAW NP) at or under $1.50, good for the day. Do not place a stop loss at this time, as we want this position to protect us against any intra-day volatility tomorrow.

In terms of contract sizing, that’s entirely up to you. But as a general guideline, this protective put position should be weighted in a way to cover any losses from your ADM and/or FRE call positions. Therefore, if you have 3 ADM calls, 3 FRE calls, and 3 Apple calls, I would look to purchase 3 DIA puts. That way, you’ve successfully “hedged” 33% of your long exposure by using these DIA protective puts.

Lock and load!

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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