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Have You Insured Your Stocks?



 
 
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  #1  
Old November 29th 09, 03:45 PM posted to misc.invest.canada
Amos Hannah
external usenet poster
 
Posts: 12
Default Have You Insured Your Stocks?

Many people think of options trading as very risky and suitable only
for the "high rollers". In this article we will demonstrate one of the
ways options can be used in conservative financial portfolios.
The basic definition of a put option is that it gives the owner the
right, but not the obligation, to sell 100 shares of the underlying
stock at the strike price anytime before expiration. If I buy 100
shares of XYZ at $136.50 or $13,650 and buy one contract of the Oct
$135 put for $10.50 or $1050, I have a total investment of $14,700.
This position is called a married put; we are long the stock and long
the put (long means we own the stock or option; short means we have
sold it and have an obligation to buy it back). If XYZ goes up in
price, my stock will appreciate but my put will expire worthless. On
the other hand, if XYZ decreases in price, my put will increase in
value and make up for a portion of my loss on the stock price, i.e.,
the put acts as insurance for my stock. A married put is analogous to
your homeowners insurance; you paid $1000 at the beginning of the year
for insurance to cover your home in case of damage from fire, storms
and so on. At the end of the year, your home was not damaged and you
lost the $1000 you paid for insurance. On the other hand, if a storm
had caused $20,000 of damage to your home, the insurance company would
have paid to have it repaired and you would be glad you had paid that
$1000 bill for the insurance.
The married put is similar; if the stock price does nothing, our put
expires worthless and we did not need our insurance. In this example
with the hypothetical company, XYZ, the insurance cost us $1050 (the
cost of the put option). But if you are watching the evening news and
see the CEO of XYZ being escorted from his office by FBI agents in
handcuffs, you begin to worry. The next morning, XYZ opens at $92, but
we look at our account online and see a balance of $13,700 - we are
only down $1000 or 7% when our stock has collapsed by over 30%; those
may not be the exact prices, but you get the idea. Some of our stock
price loss has been covered by the put.
Let's assume you own 100 shares of ABC that you bought over a year
ago, and have a nice gain in the stock. You realize an earnings
announcement is coming after the market closes and want to protect
your gains, but still be able to take advantage of any gains that
might occur after the announcement. To form a married put position
with your 100 shares of ABC, you buy the July $550 put for $14.20 or
$1420. ABC missed the market estimates for its earnings and the stock
closed at $520 on July 20, a $2800 loss in one day on your stock
position. But the put option you bought for $14.20 is now worth $30,
so you gained $1580 on your put option, reducing the $2800 loss on the
stock by over 56% to $1220.
However, buying puts on each stock would be rather tedious if I want
to protect my entire stock portfolio. In that case, using index
options that roughly match your portfolio is one answer. If my stocks
are large companies in the Standard and Poors 500, then the OEX put
options (the S&P 100) might be a good fit; the SPX options
(S&P 500) represent a broad range of stocks, including many mid-
sized companies. The NDX options (NASDAQ 100) would be a good choice
for a high technology portfolio, since this index is made up of the
largest 100 companies in the NASDAQ. The best portfolio insurance
might be a mixture of SPX and NDX put options, proportioned in
accordance with the stock holdings.
The essence of the married put strategy is buying insurance on your
stock position. If the stock price drops, your gain on the put
position offsets much of the loss on the stock. But if the stock
trades up in price, you can enjoy all of that gain minus the cost of
the put. The married put strategy is conservative, but there is no
free lunch in the markets (or anywhere else in a free society). Our
downside protection, in the form of the put, costs us a small amount
to establish. So, if our stock only moves up a little bit each month,
we may only break even after paying for our put. But when the big
crash comes, I may feel much more comfortable because my stocks are
insured.

Start Following MMaking 51% to 234% in Pure Profit With 1 Stock Pick:
http://mrcstksye.key.to/
  #2  
Old December 2nd 09, 11:03 AM posted to misc.invest.canada
Tony[_10_]
external usenet poster
 
Posts: 729
Default Have You Insured Your Stocks?

Needless to say the big crash will be much bigger than the last crash. We
remember the stories about the old economy and the *new* economy (the
dotcom bubble). We will also remember the one about the new economy and
P/E ratios of 50 being the norm when the market crashes tits up aplenty.

Amos Hannah wrote:

Many people think of options trading as very risky and suitable only
for the "high rollers". In this article we will demonstrate one of the
ways options can be used in conservative financial portfolios.
The basic definition of a put option is that it gives the owner the
right, but not the obligation, to sell 100 shares of the underlying
stock at the strike price anytime before expiration. If I buy 100
shares of XYZ at $136.50 or $13,650 and buy one contract of the Oct
$135 put for $10.50 or $1050, I have a total investment of $14,700.
This position is called a married put; we are long the stock and long
the put (long means we own the stock or option; short means we have
sold it and have an obligation to buy it back). If XYZ goes up in
price, my stock will appreciate but my put will expire worthless. On
the other hand, if XYZ decreases in price, my put will increase in
value and make up for a portion of my loss on the stock price, i.e.,
the put acts as insurance for my stock. A married put is analogous to
your homeowners insurance; you paid $1000 at the beginning of the year
for insurance to cover your home in case of damage from fire, storms
and so on. At the end of the year, your home was not damaged and you
lost the $1000 you paid for insurance. On the other hand, if a storm
had caused $20,000 of damage to your home, the insurance company would
have paid to have it repaired and you would be glad you had paid that
$1000 bill for the insurance.
The married put is similar; if the stock price does nothing, our put
expires worthless and we did not need our insurance. In this example
with the hypothetical company, XYZ, the insurance cost us $1050 (the
cost of the put option). But if you are watching the evening news and
see the CEO of XYZ being escorted from his office by FBI agents in
handcuffs, you begin to worry. The next morning, XYZ opens at $92, but
we look at our account online and see a balance of $13,700 - we are
only down $1000 or 7% when our stock has collapsed by over 30%; those
may not be the exact prices, but you get the idea. Some of our stock
price loss has been covered by the put.
Let's assume you own 100 shares of ABC that you bought over a year
ago, and have a nice gain in the stock. You realize an earnings
announcement is coming after the market closes and want to protect
your gains, but still be able to take advantage of any gains that
might occur after the announcement. To form a married put position
with your 100 shares of ABC, you buy the July $550 put for $14.20 or
$1420. ABC missed the market estimates for its earnings and the stock
closed at $520 on July 20, a $2800 loss in one day on your stock
position. But the put option you bought for $14.20 is now worth $30,
so you gained $1580 on your put option, reducing the $2800 loss on the
stock by over 56% to $1220.
However, buying puts on each stock would be rather tedious if I want
to protect my entire stock portfolio. In that case, using index
options that roughly match your portfolio is one answer. If my stocks
are large companies in the Standard and Poors 500, then the OEX put
options (the S&P 100) might be a good fit; the SPX options
(S&P 500) represent a broad range of stocks, including many mid-
sized companies. The NDX options (NASDAQ 100) would be a good choice
for a high technology portfolio, since this index is made up of the
largest 100 companies in the NASDAQ. The best portfolio insurance
might be a mixture of SPX and NDX put options, proportioned in
accordance with the stock holdings.
The essence of the married put strategy is buying insurance on your
stock position. If the stock price drops, your gain on the put
position offsets much of the loss on the stock. But if the stock
trades up in price, you can enjoy all of that gain minus the cost of
the put. The married put strategy is conservative, but there is no
free lunch in the markets (or anywhere else in a free society). Our
downside protection, in the form of the put, costs us a small amount
to establish. So, if our stock only moves up a little bit each month,
we may only break even after paying for our put. But when the big
crash comes, I may feel much more comfortable because my stocks are
insured.

Start Following MMaking 51% to 234% in Pure Profit With 1 Stock Pick:
http://mrcstksye.key.to/


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Using my technical prowess and computer abilities to answer questions
beyond the realm of understandability

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