TABLE: How One Hedge Might Work
Since put options increase in value when stock prices fall, you could protect a
diversified stock portfolio from a sudden market decline by purchasing puts in
the Standard & Poor's 100 Index, known as "OEX."
1 You determine you'll need five put contracts to protect your $250,000
portfolio by using this formula: Divide the stocks' value by the value of the
index* times the underlying number of shares, which is most often 100. The math
in this case: $250,000 divided by (529.59 X 100).
2 You only want the protection for the next two months, so you purchase
contracts that expire in the middle of October. You buy "at the money" puts
at a strike price of 530. They trade at 91/2 points, or $950 per contract, so
you need to shell out $4,750 for this "insurance."
3 Should the market suffer a 10% correction, your portfolio would decline by
$25,000. The puts, at expiration, would be worth 53.67 points per contract,
resulting in a gain of $22,085, or about 88% of your portfolio's losses. If the
stock market fell 20%, the puts would recapture 96% of your losses.
4 If the stock market continues its ascent or remains flat, the options expire
worthless, and you are out the $4,750 you paid for them.
* All prices are as of Aug. 15, 1995
DATA: SWISS AMERICAN SECURITIES INC.