What is a 'Fence (Options)'

A fence is an options strategy that establishes a range around a security or 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 call option with a 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. Expirations should be the same.

A collar option is a similar strategy offering the same benefits and drawbacks. The main difference is that the collar uses only two options, the 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 premium paid to buy the long put.

BREAKING DOWN 'Fence (Options)'

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 combination strategy, similar to collars and iron condors.

Both fences and collars are defensive positions, which protect a position from a decline in price while 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 out-of-the-money (OTM) put further offsets the cost of the more expensive at-the-money put and brings the total cost of the strategy closer to zero.

Another way to view a fence is the combination of a covered call and an at-the-money (ATM) bear put spread.

Constructing a Fence

To create a fence, the investor starts with a long position in the underlying asset, whether it is a stock, index, commodity, or currency. The trades on the options, all having the same expirations include:

  • sell or write a call with a strike price higher than the current price of the underlying
  • buy a put with a strike price at the current price of the underlying or slightly below it
  • sell or write a put with a strike price lower than the strike of the short 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. Next, buy a put option with a strike price of $50. Finally, sell another put with a strike price of $45. All options have three months to expiration.

The premium gained 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. 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) = zero.

Of course, this is an ideal result. the underlying asset may not trade right at the middle strike price and volatility conditions can skew prices one way or the other. However, the net cost or debit should be small. And a net credit is also possible.

  1. Fence

    A risk-mitigating investment strategy that utilizes options to ...
  2. Iron Condor

    An iron condor is an options strategy that involves buying and ...
  3. Put Option

    A put options gives the owner the right to sell a specified amount ...
  4. Iron Butterfly

    An iron butterfly is a options strategy created with four options ...
  5. Swing for the Fences

    To "swing for the fences" means to attempt to earn large returns ...
  6. Currency Option

    A contract that grants the holder the right, but not the obligation, ...
Related Articles
  1. Investing

    Long on Oil? Hedge Falling Oil Prices with Options

    With no end to the oil slump in sight, here are some risk management strategies using options to protect your oil positions.
  2. Investing

    How a Protective Collar Works

    Find out how a protective collar is a good strategy for getting downside protection that is more cost-effective than merely buying a protective put.
  3. Trading

    Bear Put Spreads: An Alternative to Short Selling

    This strategy allows you to stop chasing losses when you're feeling bearish.
  4. Managing Wealth

    Costless Collars: Because Asset Allocation Is Not Enough

    Collars are extremely flexible, and can be much more beneficial to your portfolio than asset allocation.
  5. Investing

    Minimize Risk With The Long Collar

    Think your favorite stock is on the way down? This simple option-trading strategy can help you manage your risks without selling the stock.
  6. Trading

    The Basics of Options Profitability

    Learn the various ways traders make money with options, and how it works.
  7. Trading

    Index Options: A How-To Guide

    Index options, financial derivatives that derive their value from a stock index, can provide stability and peace of mind for less risky investors.
  8. Trading

    Introduction To Put Writing

    Selling/writing a put is a strategy that investors can use to generate income or to buy stock at a reduced price. Learn a strategy that produces income.
  1. When does one sell a put option, and when does one sell a call option?

    An investor would sell a put option if her outlook on the underlying was bullish, and would sell a call option if her outlook ... Read Answer >>
  2. What happens when a security reaches its strike price?

    Learn more about the moneyness of stock options and what happens when the underlying security's price reaches the option ... Read Answer >>
  3. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
Trading Center