A “fig leaf” is a term used in options trading to describe a strategy where an investor combines a protective put and a covered call to reduce the cost of the protective put. This strategy aims to provide downside protection for an existing long stock position while generating income and managing the cost of insurance.

Here’s how a fig leaf works:

1. Long Stock Position: The investor begins with an existing long position in a stock, which means they own the underlying asset and expect it to appreciate over time.

2. Purchasing a Protective Put: To protect against potential downside risk, the investor purchases a put option on the same underlying stock. This put option acts as insurance, providing the investor with the right to sell the stock at a predetermined strike price if its market price declines.

3. Selling a Covered Call: To generate income and offset the cost of the protective put, the investor simultaneously sells a call option on the same underlying stock. The call option also has a specific strike price and expiration date, giving the buyer the right to purchase the stock at the strike price.

The combination of owning the protective put and selling the covered call is referred to as the “fig leaf” strategy.

Reasons to Use a Fig Leaf:

The fig leaf strategy is used for a combination of reasons, including:

1. Risk Management: The primary objective is to limit potential losses on the long stock position, especially if the investor expects short-term volatility or specific events that might negatively impact the stock’s price.

2. Income Generation: By selling the covered call, the investor receives a premium, which generates income and can offset the cost of the protective put. This effectively reduces the net cost of implementing downside protection.

3. Participation in Potential Gains: While the protective put limits potential losses, the fig leaf strategy allows the investor to continue participating in any potential stock price appreciation. If the stock rises, the call option sold at a lower strike price will likely not be exercised, and the investor can benefit from the upward movement.

4. Peace of Mind: Fig leaf strategies provide peace of mind for investors who are bullish on a stock but want to protect their investment from short-term volatility or specific events that might negatively impact the stock’s price.

Considerations and Risks:

1. Costs: The fig leaf strategy involves costs, including the premium paid for the protective put and the potential loss of upside potential if the stock appreciates beyond the call strike price.

2. Strike Prices and Expiration Dates: The strike prices and expiration dates of the put and call options should be selected carefully to provide the desired level of protection, generate income, and match the investor’s expectations regarding the stock’s performance and timing.

3. Market Volatility: High volatility can impact the cost of the fig leaf strategy. It can also affect the likelihood of the call option being exercised or the put option’s value.

4. Assignment Risk: There is a risk of being assigned the stock if the call option is exercised. In some cases, investors may need to have sufficient capital or be prepared to buy the option back to avoid assignment.

The fig leaf strategy is a more complex options trading strategy that combines elements of protective puts and covered calls. It is used to provide downside protection, generate income, and participate in potential stock price gains. As with any options strategy, careful consideration of strike prices, expiration dates, costs, and market conditions is essential when implementing the fig leaf strategy.