Essentially, we are taking advantage of our ability, as a personal investor, to better handle time-related risks than perhaps an institutional investor would, and then transforming that into a actionable investment opportunity. In today’s article, I’ll go into detail about how it is this position can be entered to create a temporarily market-neutral portfolio, and save your portfolio from some short-term market volatility.
The trick to entering a Short-Put Market Neutral Position is to have an understanding of how much risk your portfolio is able to tolerate, and contrast it against how much risk you think is present in the current market environment. From there, you’ll want to choose an expensive put option to sell, which will act as your backstop against company specific risk. The more expensive the premium, the greater your income, but the less company specific risk you are exposed to.
From there, you’ll also want to buy a put at a position that is further out of the money to act as your short-term volatility in the macro-economic environment. The net effect will be that you are protected against down-side risk up until the break-even point of the put that was sold into the market at a premium, while still being able to maintain upside exposure to the position, and even an opportunity to increase your exposure should the stock begin to unexpectedly rise.
Realistically, positions like the Long-Call and the Short-Put positions may seem to be a bit confusing at first. If such is the case, remember that it is always important to invest within your comfort zone. However, you’re only ever a short discussion with your advisor away from expanding your investing capabilities. For example, should you be currently be exposed to Euro-risks, it might be possible to even increase the cash flow currently being generated by your portfolio through a Short-Put strategy.
However, since currencies tend to move in fairly small increments in comparison to equities, you could easily justify working the position into a Euro-currency ETF, as opposed to the currency itself, and therefore greatly decreasing the costs associated with entering the position.
From there you have control over exactly how it is you’d like to protect your portfolio, as well as exactly how large a position you’d like to take on. Realistically, there’s no reason why you can’t turn this into a full blown strategy within your portfolio itself, so long as you have the capacity to diversify out the company specific risks associated with the position.
Remember, even though this kind of position leaves you less exposed to major macroeconomic risks, company-specific shortfalls are always in play.