jbenko_IHB
New member
You wouldn't dare go without home insurance would you? How about car insurance? Health?
So the question I have for you is why wouln't you insure your equities? Especially if you have a significant position.
Many don't wish to learn about the stock market because of fear that it's too complex. I'll be first to tell you that it's not. It's complex to successfuly day trade, but it's not complex to learn strategies that will let you sleep at night better than when you were itty bitty in the arms of your mother.
Let's use Cisco Systems as an example. (CSCO)
You just bought 1,000 shares @ today's close of $ 17.16 for $ 17,160 dollars.
The way you will insure your investment is through option contracts. You can do this by either buying long term puts or writing calls. There are numerous ways to play this, however if you are not the one to watch this on a daily basis lets focus on writing option contracts expiring January 15, 2009. This gives you a little over a year till expiration.
Below is a list of call option contracts expiring January 15, 2009.
Strike Symbol Price
10.00 WCYAB.X 8.75
12.50 WCYAV.X 7.00
15.00 WCYAC.X 5.45
17.50 WCYAW.X 4.15
20.00 WCYAD.X 3.05
25.00 WCYAE.X 1.51
27.50 WCYAY.X 1.11
What is an option contract? If you are the seller then it simply gives someone else the right to buy your shares for the amount listed on the contract -- the strike price. If you are the buyer of the contract, you have the right but not the obligation to buy the stock for the strike price listed. So for example look at WCYAW.X contract. The strike price is 17.50 and the premium is 4.15. The premium is the price you will buy it for or receive if selling. Here we will focus on writing calls, so we will be the seller. Rule of thumb is for every 100 shares you own of the underlying security you can sell 1 option contract. This is because each option contract is bundled in 100 shares. So if you were to sell 1 option contract at 4.15, you will actually get $415 dollars. Multiply this by 10 (1,000 shares/100) and you will get $4,150 dollars less transaction fees.
So your position is as follows.
$17,160 in Cisco shares.
$4,150 credit for selling 10 Cisco option contracts.
This means that if the stock rises past 17.50 strike, it will be exercised against you and your shares will be called away. Don't be scared...its ok. You received a premium of $4,150 for someone to have that right. Remember there is no downward risk to selling call options. You risk is upward, the fact that you won't capture any rise in stock past 17.50. This is why it's important to have equal amount of contracts sold to shares that you own. 100 shares = 1 contract. You don't want to have more than the amount of stock you own. This is because any upward movement in stock price past the strike is something you have to pay for. If you don't own the shares already, you have to buy them in the market and deliver them. It can be costly. Don't worry though, I doubt your broker will even consider allowing you to write naked options (meaning you don't own the stock) unless you sign numerous documents and have enough capital to front as liability in case the stock skyrockets.
Ok back to business. Lets do some math to find out what is our max loss here and max gain. This is easy.
Max gain is the premium plus any movement in stock till 17.50. So $4,150 + $340 = $4,490 or 21.65 a share. (26.2% gain max gain) Not bad for a little over a year.
Max loss is stock price you paid less the premium you received. So $17,160 - $4,150 = $13,010 or 13.01 a share.
If you were to hold the stock just outright, your max loss is the full $17,160.
So the strategy is obvious...max gain of 21.65 a share and 13.01 max loss per share.
The important factor when writing calls is choosing the price. So to make it easier, simply give your stock a target price you think it will be at expiration of the contract you want to write.
The most benefitial part of writing calls is that it captures gains even in a flat market. Let's say that your shares go from 17.16 to 25 six months later giving you a handsome return. Another six months go by, and the stock goes from 25 back to 17.16. Your gain is a big ZERO. You probably even lost some money due to inflation or opportunity loss.
If you sell some calls then if the stock stays at 17.16 a year later, you lost nothing on the value of the share, but gained 25% roughly on the premium collected.
If you think the stock will go to 25 within a year, then you might want to sell some 25 strike calls. This will give you a greater rate of return if it gets there and but a smaller protection.
The premium is 1.51 for a 25 strike call. So you will collect $1,510 + the movement of stock till 25 (7.84 a share). So total return would be 54.5% if it gets to 25 + premium. Any movement after 25 is a wash as each penny movement after 25 will cost you a penny in the option contract. So you are capped at 25 + premium. At the same time you have a smaller protection. With a 1.51 guaranteed premium, your downward protection is about 8.8% (17.16-1.51=15.65). So 54.5% max gain and 8.8% protection.
If you think the stock market will go down big, then you want to write deep in the money lets say at 10 strike price. The deeper you go into the money, the deeper the protection but your gains are really limited as well.
After a year, you can write another contract based on a new target you set for the stock. Rinse and repeat.
So if you don't feel like monitoring the market, then why not write some calls 6 months or a year from now to give you some protection and even give you a nice return in a flat or rising market.
You will get max yield if you write calls expiring in a month, this is because a month is more volatile than a year. So the premiums are higher. In Cisco's example, 1 month out calls at strike price (17.50) will generally yield 6-8% per month. Multiply this by 12 and you can see that gains can be 70-90% returns annually. Well dollar for dollar 1 month calls are cheaperr, but if you divide days till expiration (coverage) by the premium you will see that they are more expensive.
I write month out, sometimes a week out calls if the moment is right. Often I will buy a year out puts to give me max protection and write short term covered calls to capture short term gains. But this is another lesson another time.
I hope this makes sense. I tend to over-explain things. Many of you already know this so this is aimed at those that don't.
Good luck.
So the question I have for you is why wouln't you insure your equities? Especially if you have a significant position.
Many don't wish to learn about the stock market because of fear that it's too complex. I'll be first to tell you that it's not. It's complex to successfuly day trade, but it's not complex to learn strategies that will let you sleep at night better than when you were itty bitty in the arms of your mother.
Let's use Cisco Systems as an example. (CSCO)
You just bought 1,000 shares @ today's close of $ 17.16 for $ 17,160 dollars.
The way you will insure your investment is through option contracts. You can do this by either buying long term puts or writing calls. There are numerous ways to play this, however if you are not the one to watch this on a daily basis lets focus on writing option contracts expiring January 15, 2009. This gives you a little over a year till expiration.
Below is a list of call option contracts expiring January 15, 2009.
Strike Symbol Price
10.00 WCYAB.X 8.75
12.50 WCYAV.X 7.00
15.00 WCYAC.X 5.45
17.50 WCYAW.X 4.15
20.00 WCYAD.X 3.05
25.00 WCYAE.X 1.51
27.50 WCYAY.X 1.11
What is an option contract? If you are the seller then it simply gives someone else the right to buy your shares for the amount listed on the contract -- the strike price. If you are the buyer of the contract, you have the right but not the obligation to buy the stock for the strike price listed. So for example look at WCYAW.X contract. The strike price is 17.50 and the premium is 4.15. The premium is the price you will buy it for or receive if selling. Here we will focus on writing calls, so we will be the seller. Rule of thumb is for every 100 shares you own of the underlying security you can sell 1 option contract. This is because each option contract is bundled in 100 shares. So if you were to sell 1 option contract at 4.15, you will actually get $415 dollars. Multiply this by 10 (1,000 shares/100) and you will get $4,150 dollars less transaction fees.
So your position is as follows.
$17,160 in Cisco shares.
$4,150 credit for selling 10 Cisco option contracts.
This means that if the stock rises past 17.50 strike, it will be exercised against you and your shares will be called away. Don't be scared...its ok. You received a premium of $4,150 for someone to have that right. Remember there is no downward risk to selling call options. You risk is upward, the fact that you won't capture any rise in stock past 17.50. This is why it's important to have equal amount of contracts sold to shares that you own. 100 shares = 1 contract. You don't want to have more than the amount of stock you own. This is because any upward movement in stock price past the strike is something you have to pay for. If you don't own the shares already, you have to buy them in the market and deliver them. It can be costly. Don't worry though, I doubt your broker will even consider allowing you to write naked options (meaning you don't own the stock) unless you sign numerous documents and have enough capital to front as liability in case the stock skyrockets.
Ok back to business. Lets do some math to find out what is our max loss here and max gain. This is easy.
Max gain is the premium plus any movement in stock till 17.50. So $4,150 + $340 = $4,490 or 21.65 a share. (26.2% gain max gain) Not bad for a little over a year.
Max loss is stock price you paid less the premium you received. So $17,160 - $4,150 = $13,010 or 13.01 a share.
If you were to hold the stock just outright, your max loss is the full $17,160.
So the strategy is obvious...max gain of 21.65 a share and 13.01 max loss per share.
The important factor when writing calls is choosing the price. So to make it easier, simply give your stock a target price you think it will be at expiration of the contract you want to write.
The most benefitial part of writing calls is that it captures gains even in a flat market. Let's say that your shares go from 17.16 to 25 six months later giving you a handsome return. Another six months go by, and the stock goes from 25 back to 17.16. Your gain is a big ZERO. You probably even lost some money due to inflation or opportunity loss.
If you sell some calls then if the stock stays at 17.16 a year later, you lost nothing on the value of the share, but gained 25% roughly on the premium collected.
If you think the stock will go to 25 within a year, then you might want to sell some 25 strike calls. This will give you a greater rate of return if it gets there and but a smaller protection.
The premium is 1.51 for a 25 strike call. So you will collect $1,510 + the movement of stock till 25 (7.84 a share). So total return would be 54.5% if it gets to 25 + premium. Any movement after 25 is a wash as each penny movement after 25 will cost you a penny in the option contract. So you are capped at 25 + premium. At the same time you have a smaller protection. With a 1.51 guaranteed premium, your downward protection is about 8.8% (17.16-1.51=15.65). So 54.5% max gain and 8.8% protection.
If you think the stock market will go down big, then you want to write deep in the money lets say at 10 strike price. The deeper you go into the money, the deeper the protection but your gains are really limited as well.
After a year, you can write another contract based on a new target you set for the stock. Rinse and repeat.
So if you don't feel like monitoring the market, then why not write some calls 6 months or a year from now to give you some protection and even give you a nice return in a flat or rising market.
You will get max yield if you write calls expiring in a month, this is because a month is more volatile than a year. So the premiums are higher. In Cisco's example, 1 month out calls at strike price (17.50) will generally yield 6-8% per month. Multiply this by 12 and you can see that gains can be 70-90% returns annually. Well dollar for dollar 1 month calls are cheaperr, but if you divide days till expiration (coverage) by the premium you will see that they are more expensive.
I write month out, sometimes a week out calls if the moment is right. Often I will buy a year out puts to give me max protection and write short term covered calls to capture short term gains. But this is another lesson another time.
I hope this makes sense. I tend to over-explain things. Many of you already know this so this is aimed at those that don't.
Good luck.
