The Smart Investor

Are my investments safe in a choppy market

2012-08-14T17:16:00.000-07:00

Options collar....

Now that we understand that we can really do wonders with options(increase upside) by opening a new revenue stream, its time to use options to limit your loss. Sounds interesting..

In todays market where stocks are up one day and down the other, it is really important to make sure that your investments are safe no matter what happens in the market. To achieve this we use a part of money we received by selling call options and use that to buy out of money put option.

In layman's terms it is a circuit breaker which is meant to prevent extreme losses. Time to put the strategy to test with an example.

Say you buy Barrick Gold (ABX) at market which is $34.14 on Aug 14, 2012

Now you sell the out of money call with strike price of 37 expiring Jan 2013 and collect $1.60

At the same time you buy out of money put with strike price of 30 and same expiry and pay $1.33

Strike	Symbol	Last	Chg	Bid	Ask	Vol	Open In

CALL

37.00

ABX130119C00037000

1.61

0.08

1.60

1.65

4,320

PUT

30.00

ABX130119P00030000

1.31

0.02

1.30

1.33

9,786

Net cost is 34.14 - 1.60 + 1.33 = 33.87

There are 3 scenarios

1 Price goes beyond 37.00 and the stock is called and the net profit is (37.00 - 33.87)/33.87 = 9.24%

2 Price goes to $20, it would have been devastating but thanks to the put option, we can sell the stock for $30

Net loss is (33.87 - 30)/33.87 = -11.4%

3 Price stays flat and both the options expire worthless and we still made a little gain

Net Profit is (34.14 - 33.87)/34.14 = 0.8%

Bottom line is that by selling a call we are limiting our upside while collecting extra revenue and by buying a put we are buying insurance by paying the premium for the same. Both put and call options are out of money with the same expiry. general rule of thumb is to leave yourself a potential upside of 10% and max loss of 10%.

What are stock options

2012-05-01T20:21:00.000-07:00

If you already own stocks in the market and are getting dividend(lucky you) or waiting for stocks to go up(start praying), there are a lot of catalysts in the market that can go against you. How do you protect your portfolio without incurring any additional cost and generate additional cash flow at the same time?

Sounds too good to be true, Your answer is options. We need to understand some basic terminology for that first.
OPTION: An option is a contract that gives the buyer the right, not the obligation to buy or sell an underlying asset at a specific price on or before a certain date.

Still confused? Let's try and break it with this example. For simplicity we will use real estate as the underlying asset and in the next blog I will use real data from finanace.yahoo.com to show the power of options.

Say for example that you own a house(asset) which is worth $200,000 which you plan to sell and someone approaches you with a proposition for the right to purchase the house from you for $215,000 within 6 months and pays you a premium $10,000 to keep it off the market. Remember he may or may not show up at the end of 6 months to purchase the house from you, but you are obligated to keep it off the market and sell the house to him for $215,000 within the defined timeframe. At the end of 6 months there are three scenarios as the price of the house can go up, down or sideways.
1 SIDEWAYS: He would not buy a $200,000 house for $215,000 + premium($10,000) and does not show-up and you keep the premium(sweet). And you can put the house on the market again or sign another contract like the one mentioned above and keep on collecting extra money.
2 UP: It so happens that city decides to run subway line close to your house and the price shoots up to $300,000. Even though the price of the house has gone up, you are bound by legal obligation to sell the same asset for $215,000 keeping the premium in your pocket as well.
3 DOWN: It turns out that there was insect infestation in the house and due to which the price of the house has dropped to $175,000. Again he will not buy the house for $215,000 considering the value of the house has dropped. You still get to keep the $10,000 premium and do another contract or sell it.

This example demonstrates that owning the asset(stock or house) has risks involved but by doing options you can create downside protection(hedging) limiting your upside potential at the same time.

Are you a smart Investor?

2012-05-01T17:51:00.000-07:00

Strange way to start, but who should not follow this blog?

1 If you are happy with your GIC investments making 1.5 to 2% before taxes, Considering the inflation you are bleeding money while it is sitting in the GIC's every second.

2 If you think investing in real-estate alone will make you rich. Never put all your eggs in one basket... remember what happened during the housing bubble burst in US.

For the rest of the population, this forum will help you make guaranteed returns on your investments from day one.

There are no two ways to make money, the only way to make money is the smart way. Let your money make more money for you. I used to think stock options resemble gambling till I played them and understood the beast. Trust me there are two faces to this coin as well, it can be risky or safe depending upon how you play them. You can either be a gambler buying options hoping to make a winning or be a dealer selling options and making money.

Have you ever seen a casino going out of business? Probably not, all the games in the casino are planned so the casino has more than 65% chances of winning. Guess what options is better, with my strategy you will have over 95% probability of winning.