Monday, August 24, 2009
As promised I will give you a quick run-down of my options contracts and the price acquired. Remember, an option gives you the right, but not the obligation, to buy or sell as share at a later date. The buy or sell side depends on the type of option (call or put).
There are a few effective means of utilizing options even if you are a long only investor. The best one is to use the technique known as "hedging" your positions.
Basically this means that if I own shares of, say, Teck Resources, but I think the market may take a serious dive overall, I can cover the losses on my shares. Market timing is difficult and thus this is a fairly cheap way to cover your losses and roll them back into the stock.
Here's an example:
Say I purchased Tck.b on January 1 of 2007 $33.00 per share. Now I know the fundamentals of this particular company are strong and that they are in an industry where they have good market share, good trade relations, and churn out some serious cash.
However I also know the fundamentals of the broad market are not looking so hot, and I also know that when major indexes dive hard, even the best stocks get dragged down by the "Fear Factor".
So what I can do is hedge my long position in Teck with a put option contract (or several of them) to make up for any broad losses I might take. Because I am trying to hedge for a long period of time, I personally go with an option contract that is at least 9 - 12 months out (which is usually about the furthest out you can have contracts written on the open market).
So I will buy the put contract (each contract = 100 shares. Lets say I have 1000 shares of Teck so I will actually buy 10 contracts) at $32.50. Because there is a huge time premium on this type of option I will probably pay around $5.00 per contract. Basically I am using $5000.00 to protect my $33,000.00 investment. Or in other words I am risking about 15% to protect the 100%.
Now, if the stock goes up 100% from there to $66.00 by January 1 2008 I have made $33,000 and my "insurance" has expired worthless. So I forfeit the $5000 for peace of mind and I'm net $28,000.
However, let's say the stock does exactly what it actually did. After a very long-term head and shoulders it tanked all the way down to $3.35! (I recommended it as a buy not very long after this point, remember). Well now your stock is only actually worth $3,350.00!
But not to fear, those put options have been growing in value with each passing day the stock has tanked. Even if you were a bad timer and sold them when the stock was at $7.50/share, they would still be worth $22.50 + per contract, giving you $22,500 back. If you then took that money and piled it back into the stock (even at $7.50), that would have landed you an additional 3000 shares.
Look at today. The stock closed at around $28.50. Your now 4000 shares would be worth over $90,000.00!
Of course, you say, this is a past-tense example. You can quantify ANYTHING using the past.
Fine. I will show you what I'm doing now and we can quantify that in the next 6 months using the future!
Here are the Put contracts I have taken out over the last 7 trading days:
PUT BAC November @ 17.50 - 10 contracts @ $2.00 / share
PUT BMO December @ 40.00 - 5 contracts @ $3.00 / share
PUT COF January 2010 @ 40.00 - 5 contracts @ $6.60 / share
PUT JPM December @ 40.00 - 10 contracts @ $3.00 / share
PUT GS December @ $170.00 - 2 contracts @ $18.00 / share
There will be a few more added over the next week or two (unless something really violent and to the downside already starts). I'll keep you posted.
Happy trading all!