Anyone ever tried this. Say you worked for an oil and gas start up in 2014 type scenario? Did you use etf or indexed options? I'm largely ignorant to options but have bonuses over the next 3 years that will largely vanish if my industry takes any kind of a dive.

I've evaluated a number of times for clients. Discussed in depth with a few. Never implemented as it was ultimately deemed too expensive in each case for a somewhat remote chance outcome.

Help me ballpark total cost of option to hedge the following. Using round number here. Say I want to hedge 100,000 in bonus paid in equal installments over the next 3 years. The underlying industry index is valued at 100 per share today. If I wanted to buy options at 90, 80, and 70 per share and spread it out over a 2-3 year horizon how much are we talking. 10k to protect 100k? I don't need to fully hedge but if the index is at 80 in 1 year and 70 the following I'd like to see 75k or so.

treetop flyer said:

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Help me ballpark total cost of option to hedge the following. Using round number here. Say I want to hedge 100,000 in bonus paid in equal installments over the next 3 years. The underlying industry index is valued at 100 per share today. If I wanted to buy options at 90, 80, and 70 per share and spread it out over a 2-3 year horizon how much are we talking. 10k to protect 100k? I don't need to fully hedge but if the index is at 80 in 1 year and 70 the following I'd like to see 75k or so.

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In options, that's basically impossible to answer without knowing more specifics like what the price of the actual options at those strikes are (ie the answer could be 'cheap' if the implied vol of the index is low or 'ridiculous' if its high vol). Compound that.... generally, especially if you are talking cash bonus, it's very likely a ****ty hedge regardless of what you think. An option goes deep in the money, no guarantees you'll find a buyer and if you do, unless the index is super liquid, you are getting you face ripped off liquidating the option and getting the cash. Generally, unless you have an actual equity to hedge, putting premium out to hedge your bonus is a silly proposition in my opinion.

treetop flyer said:

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Help me ballpark total cost of option to hedge the following. Using round number here. Say I want to hedge 100,000 in bonus paid in equal installments over the next 3 years. The underlying industry index is valued at 100 per share today. If I wanted to buy options at 90, 80, and 70 per share and spread it out over a 2-3 year horizon how much are we talking. 10k to protect 100k? I don't need to fully hedge but if the index is at 80 in 1 year and 70 the following I'd like to see 75k or so.

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Use the equity most highly correlated with your stock with the most liquid options market as a proxy for your stock. If your stock is XOM or similar you may not need a proxy. If you use a proxy equity like XLE then you hedge against industry risk, but not something like your company cooking the books or underperfoming the competition. Just keep all that in mind.

Using XLE as an example, pull up the options chain for it on nasdaq.com.

http://www.nasdaq.com/symbol/xle/option-chain

Select long dated contracts (LEAPS) that are out of the money. Look at JAN 2018 and further out. Right now the longest out you can trade is JAN 2019.

XLE last traded at $69, an out of the money $63 put option expiring JAN 18 2019 will cost you $5.25 per share. You can offset that cost by selling an out of the money call at something like $75 for $3 per share. This is called establishing a collar, you lock in your downside protection with the put and offset the cost of the protective put with the call (which of course limits your upside).

Net you are looking at something like $2.25 per share with the underlying at $69 to establish that +/-10% collar. Mix and match different expiration dates and strike prices to see what the net debit is going to be for the position. Read up on IRS regulations about collars and strike price selection. Keep in mind if you need this protection for multiple years as your stock vests you will need to roll these contracts when the next year's LEAPS become available. Also if the stock blows through $75 and you sold someone a call at $75 to finance the collar, you need to be able to cover that (either have cash or already own that amount of the underlying). You can't use next year's stock bonus if you get called this year.

http://www.investopedia.com/terms/c/collar.asp

If you don't like the collar you can just buy the put, but realize you are choosing the an expensive protection option that will probably expire worthless. The collar locks you into a range for minimal cost. If you are on the E&P side I'm sure you're employer does the same thing with futures contracts.

Followup: I've never seen a collar done without already owning the underlying. Others might be able to talk about how your situation would be suited to one. You might be better off with a vertical spread of some sort.

Sounds like this is not a good solution and/or I need an advisor. Thanks.

Just to clarify, are you getting this bonus as a certain number of shares of stock each year, as a variable amount of stock for a predetermined amount of cash each year, or just as cash?

Hedging would only make sense to me in the first case.

treetop flyer said:

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Sounds like this is not a good solution and/or I need an advisor. Thanks.

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For something like this, you probably need to sit in a room with an expert for an hour or two. It's going to be tough to handle via a public message board. Not so much because of privacy, but because you need to ensure complete understanding of the problem and solution by both parties. Tough in text.