XLE : Married Put trading review for the last 4 months

Trade Idea

The main energy is XLE containing most major "big oil" companies, but tends to be volatile. Can we use this to our advantage by hedging with options ? (the main approach being to protect capital)

XLE

Trade entry on Mar 7th 2012 :
Long XLE 300 * 73.66 (Mar 7th 2012 close price) = $22,098
Long 3 XLE June 2012 Puts strike $76 costing $5.22 = $1566 *
Total trade cost = $23,664

* time value is put option cost ($5.22) – strike ($76) + underlying price ($73.66) = $2.88
intrinsic value is $2.34

2 trades were executed on 25th May 2012 (close price $65.13):
Close position : Long 3 XLE June 2012 Puts strike $76 : bought $5.22, sold at $11.00
Open position : Long 3 XLE Sept 2012 Puts strike $66.5 : price is $5.05*

* time value is put option cost ($5.05) – strike ($66.5) + underlying price ($65.13) = $3.68
intrinsic value is $1.37

Current position 5th July 2012:

REALISED GAIN/LOSS *
Closed position : Long 3 XLE June 2012 Puts strike $76 : bought $5.22, sold $11.00 = $1734 (gain)
(* including commissions)

UNREALISED GAIN/LOSS*
Open position : Long XLE 300 shares : price is $67.10 = -$1968 (breakeven)
Open position : Long 3 XLE Sept 2012 Puts strike $66.5 : price is $2.63 = -$726 (loss)
(* including commissions and assuming worst case option prices)

Total : -$960 (loss) = -4.05% (loss)

versus

Buy and Hold : -$1968 (loss) = -8.90% (loss)

Note that the latest put option (Sept 2012 at strike $66.5) has NOT helped hedge properly. The stock has advanced $1.97 ($67.10 – $65.13) from 25th May to 5th July, however the put option is down $2.42 (losing about $0.45 during the rally). Part of the reason for this is that On Friday June 29th, put options volatility got crushed due to the perception of less market risk from the European decision, and combined with the markets rallied swiftly higher, the put option actually went down a very similar amount to the stock rise (not realising an overall position delta of 50%, more like an 85% delta, due to volatility loss). Sometimes hedging in high volatility markets is frustrating.

However the option did help to hold the position, through the recent decline.
http://www.google.com/finance?chdnp=0&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1341523737167&chddm=32844&chls=IntervalBasedLine&q=NYSEARCA:XLE&ntsp=0

It had an unrealised profit of $550 when the stock was at $62.05 on Jun 25th 2012, but no action was taken, so this premium has been lost in the latest rally.

There were two dividends in the period : $84 + $93 = $177 which helps cushion the overall loss.

We need to try and pick up some more stock cheaply as we have approximately $1000 in cash from put options (realised and unrealised). The main issue is that we can’t easily get one lot of 100 shares (to make 4 put option contracts), it will have to be smaller amounts (e.g.. $1000 / $67 current price = 15 shares).

These 15 shares can either be unhedged, or we can round up to 4 contracts (but that gets expensive on its own against 315 shares). Also can’t justifiably sell 1 contract with only long 3 contracts (because that’s really only hedging 200 shares).
So one strategy could be roll Sept 2012 contract to Dec 2012 (the Sept 2012 is getting within 3 months of expiration and that contract is now 100% time value, so it is vunerable to volatility reducing further, plus on balance its decaying faster every day. We ideally want to be buying intrinsic value, and hopefully selling time value).

We can try 4 contracts in Dec 2012, then sell 1 contract against near months (e.g. Aug 2012). This gives us the original 300 shares to 3 contracts hedge, and then a diagonal spread on 1 contract, selling near month against 6 month (for 6months), hoping to provide some cash to pick up some more shares (in likely small increments, e.g. 10 shares or more).

 

XLE

So far:
The gain on hedging is $1734 – $610 – $957 = $167
The loss on stock is :
  (71.80 – 73.66) * 300 shares = -$558
  (71.80 – 66.42) * 15 shares = $81

Total strategy loss is -$310

Total buy and hold loss would be -$558

This has "saved us" $248 in losses and we have an extra 15 shares to show for the effort.
This is not significant in the short term, but over time if you can acquire a small number of extra shares on market dips, this can help with a long term dividend strategy – especially if the dividend is increased annually. You are "dollar cost averaging" into the stock, however the money does not come out of your own pocket, typically it is from the profit of selling a put option after the stock has gone down.
 

 
 

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