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Chapter 5. Advanced option strategies > Buying options to protect futures

Buying options to protect futures

Buying options to protect futures involves buying a put with long futures or buying a call with short futures. This strategy is also known as creating synthetic options, because a put combined with a long futures is similar to a call, and the call in conjunction with the short futures is similar to a put. You can make a case that if you buy an at-the-money call option while simultaneously holding a short futures position (synthetic put), or you buy a put option while simultaneously holding a long futures position (synthetic call) that the overall position will act just like a put or a call (so why bother?). However, this can be a better strategy, because it gives you added flexibility, and I use it quite a bit.

For example, you are fundamentally bullish about the hog market, but you are concerned that the upcoming Hogs and Pigs Report could move the market substantially (hopefully in your direction, but there are no guarantees). In fact, the Hogs and Pigs Report, released quarterly by the USDA, has a reputation for moving the market's locked limit, at times consecutive multiple limit days in a row. Lock-limit moves (or abnormal moves in markets without limits) is a risk every futures trader has to accept. If the Report is a bearish surprise, you could lose many times your initial margin because you might not be able to liquidate the first day or even the second. This can become a real nightmare when you're caught on the wrong side of a three-day lock-limit report, and it does happen.



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