What Is a Fence (Options)?

A fence is a defensive options 🏅strategy involving three different options that an investor deploys to protect an owned holding from a price decline, while also sacrificing potential profits.

A fence is similar to options strategies known as 澳洲幸运5官方开奖结果体彩网:risk-reversals and collars that involve two, not three optio🍸ns.

Understanding a Fence

A fence is an options strategy that establishes a range around a security or 澳洲幸运5官方开奖结果体彩网:commodity using three options. It protects against significant downside losses but sacrifices some of the underlying asset's upside potential. Essentially, it creates a value band around a position so the holder does not have to worry about market movements while enjoying the benefits of that particular position, such as dividend payments.

Typically, an investor holding a long position in the underlying asset sells a 澳洲幸运5官方开奖结果体彩网:call option with a 澳洲幸运5官方开奖结果体彩网:strike price above the current asset price, buys a put with a strike price at or just below the current asset price, and sells a put with a strike below the first put's strike. All the option's must have identical 澳洲幸运5官方开奖结果体彩网:expiration dates.

A collar option is a similar strategy offering the same benefits and drawbacks. The main difference is that the collar uses only two options (i.e., a 澳洲幸运5官方开奖结果体彩网:short call above and a long put🔥 below the current asset price). For both strategies, the premium collected by selling options partially or fully offsets the pr🍃emium paid to buy the long put.

The goal of a fence is to lock in an investment's value through the expiration date of the options. Because it uses multiple options, a fence is a type of 澳洲幸运5官方开奖结果体彩网:combination strategy, similar to collars and 澳洲幸运5官方开奖结果体彩网:iron condors.

Both fences and collars are defensive positions, which protect a position from a decline in price, while also sacrificing upside potential. The sale of the short call partially offsets the cost of the long put, as with a collar. However, the sale of the 澳洲幸运5官方开奖结果体彩网:out-of-the-money (OTM) put further offsets the cost of the more expensive 澳洲幸运5官方开奖结果体彩网:at-the-money (ATM) put and brinꦐgs the total cost of the strategy closer to൩ zero.

Another way to view a fence is the combination of a 澳洲幸运5官方开奖结果体彩网:covered call and an at-the-money (ATM) 澳洲幸运5官方开奖结果体彩网:bear put spread.

Constructing a Fence with Options

To create a fence, the investor starts with a 澳洲幸运5官方开奖结果体彩网:long position in the underlying asset, whether it is a stock, index, 澳洲幸运5官方开奖结果体彩网:commodity, or currency. The trades on the options, a🎃ll h🥀aving the same expiry, include:

• Long the underlying asset
• Short a call with a 澳洲幸运5官方开奖结果体彩网:strike price higher than the current price of the underlying.
• Long a put with a strike price at the current price of the 澳洲幸运5官方开奖结果体彩网:underlying or slightly below it.
• Short a put with a strike price lower than the long put.

For example, an investor who wishes to construct a fence around a stock currently trading at $50 could sell a call with a strike price of $55, commonly called a covered call. Next, buy a 澳洲幸运5官方开奖结果体彩网:put option with a strike price of $50. Finally,ꦉ sell another put with a strike price of $45. All options have three months to expiration.

The premium gained from the sale of the calജl would be ($1.27 * 100 Shares/Contract) = $127. The premium paid for🃏 the long put would be ($2.06 * 100) = $206. And the premium collected from the short put would be ($0.79 * 100) = $79.

Therefore, the cost of the strategy would be premium paid minus premium collected or $206 – ($127 + $79) = 0.

Of course, this is an ideal result. The underlying asset may not trade right at the middle strike price, and 澳洲幸运5官方开奖结果体彩网: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.