It seems there is some confusion with hedging positions, I will explain. Think of a hedge as a small insurance policy. In some cases with options which expire out several months, it is not a bad idea to take out a small insurance policy/hedge.
There are many ways to do this, but the simplest way is a 10% rule.
You execute this simply.
Say you bought calls on XYZ which expire in 5 months and you do not want to close the position as you still have a lot of time before expiration. If the trade is trending lower, you would buy protective puts.
Lets do an example.
You have 10K invested on XYZ calls that expire in 5 months and the stock is under pressure. You would buy puts totaling 10% of the trade, so 10% of 10K is 1K. Now you buy these puts generally just OTM or slightly ITM which expire 1 to 2 months out.
Now lets say the stock trades down and your puts pay off, but now the stock is rebounding. You close the puts with a profit, and invest the 10% hedge plus profit into averaging down into the initial position.
I hope this helps, Greg.
Thanks this does help!🤓
In the old days of series 7 semantics I think they called this a straddle position so you
protect your position with little investment whichever way the market blows down or up and realize the difference less the premium paid for the losing position of the straddle see saw position. The 10% position play and the mathematics is what baffles most less sophisticated investors or day traders. They probably ask why 10% why not 15% or 20% so there must be
a proportionate ratio in play that we who don't play the market each minute of the day and
night!!!