Fence (Options)

What Is a Fence (Options)?

A fence is a defensive options strategy including three distinct options that an investor conveys to shield an owned holding from a price decline, while likewise forfeiting expected profits.

A fence is like options strategies known as risk-reversals and collars that include two, not three options.

Figuring out a Fence

A fence is an options strategy that lays out a reach around a security or commodity utilizing three options. It safeguards against critical downside losses yet forfeits a portion of the underlying asset's upside potential. Basically, it makes a value band around a position so the holder doesn't need to worry about market developments while partaking in the benefits of that specific position, for example, dividend payments.

Typically, an investor holding a long position in the underlying asset sells a call option with a strike price over 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 principal put's strike. All the option's must have indistinguishable expiration dates.

A collar option is a comparable strategy offering similar benefits and downsides. The fundamental difference is that the collar utilizes just two options (i.e., a short call above and a long put below the current asset price). For the two strategies, the premium collected by selling options to some extent or completely balances the premium paid to buy the long put.

The goal of a fence is to lock in a venture's value through the expiration date of the options. Since it utilizes various options, a fence is a type of combination strategy, like collars and iron condors.

The two fences and collars are defensive positions, which safeguard a position from a decline in price, while likewise forfeiting upside potential. The sale of the short call to some degree counterbalances the cost of the long put, similarly as with a collar. Nonetheless, the sale of the out-of-the-money (OTM) put further counterbalances the cost of the more costly at-the-money (ATM) put and brings the total cost of the strategy more like zero.

One more method for review a fence is the combination of a covered call and an at-the-cash (ATM) bear put spread.

Building a Fence with Options

To make a fence, the investor begins with a long position in the underlying asset, whether it is a stock, index, commodity, or currency. The trades on the options, all having a similar expiry, include:

• Long the underlying asset
• Short a call with a strike price higher than the current price of the underlying.
• Long a put with a strike price at the current price of the underlying or somewhat below it.
• Short a put with a strike price lower than the long put.

For instance, an investor who wishes to build a fence around a stock currently trading at $50 could sell a call with a strike price of $55, usually called a covered call. Next, buy a put option with a strike price of $50. At last, sell one more put with a strike price of $45. All options have three months to expiration.

The premium acquired from the sale of the call would be ($1.27 * 100 Shares/Contract) = $127. The premium paid for the long put would be ($2.06 * 100) = $206. Furthermore, the premium collected from the short put would be ($0.79 * 100) = $79.

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

Of course, this is an optimal outcome. The underlying asset may not trade right at the middle strike price, and volatility conditions can skew prices for sure. Be that as it may, the net cost or debit ought to be small. A net credit is likewise conceivable.

Features

• A fence is a defensive options strategy that an investor conveys to shield an owned holding from a price decline, while likewise forfeiting expected profits.
• Every one of the options in the fence option strategy must have indistinguishable expiration dates.
• An investor holding a long position in the underlying asset develops a fence by selling a call option with a strike price over the current asset price, buying a put with a strike price at or just below the current asset price, and selling a put with a strike below the primary put's strike.