How to Handle the Volatility With Options

One of the simplest and most straightforward ways for limiting risk is to use a married put strategy; that is, the purchase of put options in combination with buying or being long related stock or index product. In a recent article I used the Financial Select Sector SPDR(XLF Quote) as an example of establishing a married put. For those looking to start bottom-fishing at the financial sector, it might work something like this:

Let's assume you're looking at the XLF, which is currently trading around $30 a share. Let's assume you ultimately want to own 1,000 shares and plan to buy in three units every $1 down; that is, you buy 333 shares at $30, 333 at $29 and 334 at $28. This would give you an average price of $29.

A Safer Way to Play Financial Stocks

For downside protection on those buys, you might look at the March $29 put, which currently has a delta of 0.32, but will have a delta of 0.48 if XLF shares trade down to $28. At that point, you'd need about 20 puts to fully hedge your long position.

There are two approaches to getting into this downside protection. One, you could scale into the purchase of puts as you purchase the stock. That is, as you buy each 333-share lot, you buy the appropriate number of put options.