fence

Fence Hedge

for stocks

A fence is a hedging strategy that creates a value band around a position to protect against market movements. It is a combination of a collar and a put spread providing a low-cost composition that shields part of the downside while allowing some upside.

This strategy is excellent for holding stocks that pay dividends as it protects the asset from market movement.


Suitability:

savvy to pro investors

Savvy Investors

This hedge requires a combination of option calls and puts and therefore is only suitable for savvy investors.

Protection:

good

Good

The risks for this strategy are low, usually allowing one to hold a position without concern.

Cost:

low to moderate

Low to Moderate

Based on the execution of three options, the premiums help offset the costs.


Example:

The steps to create a fence strategy are as follows:

  1. Start with a long position in the stock of your choice.
  2. Write (sell) a call with a strike price higher than the current price of the underlying stock.
  3. Buy a put with a strike price equal to or slightly below the current underlying stock.
  4. Write (sell) a put with a strike price lower than that of the short put.

For example, an investor purchases XYZ stock for $50. They wish to protect the position, so they create a fence. To begin, they sell a call with a strike price of $55. Next, they buy a put option with a strike price of $50. Last, they sell another put with a strike price of $45—all with three-month expiration dates.

The details are as follows:

Event Premium
Sale of the Call ($1.27 * 100 shares/contract) = $127
Long Put ($2.06 * 100 shares/contract) = $206
Short Put ($0.79 * 100 shares/contract) = $79
Total $206 – ($127 + $79) = 0

According to Investopedia, "The underlying asset may not trade right at the middle strike price, and volatility conditions can skew prices one way or the other. However, the net cost or debit should be small. A net credit is also possible."


Resources:



© 2020 Todd Moses

The strategies discussed are for illustrative and educational purposes and are not a recommendation, offer, or solicitation to buy or sell any currency or to adopt any investment strategy. There is no guarantee that any strategies discussed will be useful. Todd Moses is not a licensed securities dealer, broker, or US investment adviser or investment bank.