Insure Your Investment
You insure your home. You insure your life and the lives of your
loved ones. Why not insure your investments?
With current market conditions tossing most portfolios around,
it would make sense to protect your portfolio. After all, the
work we do significantly lowers the risk of losing money in an
investment we choose to get involved in. But we never completely
eliminate all the risk in the market.
Buying a protective put will help protect your new stock
purchases in the market. This can be really helpful when you
want to buy a particular stock, but the overall bias in the
market is down. What is a put? A put is a contract that gives
the buyer the right to sell stock at a certain price and during
a defined period of time, up to the expiration of the contract.
When you buy a stock, three possible events can occur. * The
stock can go up. * The stock can do nothing * The stock can go
down.
In two of the three scenarios above, you do NOT make money. In
one of the scenarios (where the stock goes down), you have a
significant chance to lose money. Let's focus on what happens
when you lose money.
At this point, I think it's prudent to draw a comparison. If you
drive a car, and your car is wrecked in an accident, you have
insurance to put you back "whole" or close to it, again. A put
works in similar fashion.
Suppose when you buy a stock at $80, you also buy a put that
expires in 6 months, and you pay $3 for that contract. Much like
insuring your car for the next 6 months. If nothing happens to
your car over the next 6 months, you won't get that insurance
premium returned to you, will you? You won't get it
returned...and in fact, you will usually pay another premium to
cover your car for another 6 months.
The purchase of the put means you can sell the stock at $80
anytime before the contract expires. Even if the stock drops to
$35, you have the right to sell at $80.
If the stock goes along as planned, and goes up,
congratulations, you've made money. The premium you paid for the
put was for insurance for the six months. Just like the example
with your auto insurance, that money will not be returned to you
(it was the cost of coverage).
If the stock does nothing, although you have not made any money,
you know that your investment was covered in case of something
negative happening for the last six months.
If the stock goes down, you have coverage, and you also have
choices. Remember what you own with a put is the right to sell
the stock, in this example, at $80, no matter what's the current
price of the stock (whether it is $75, $45, or even $1). * You
can sell the put in the open market for whatever is the current
value. * You can exercise the option and "put" the stock to
someone at $80, no matter what the current price of the stock.
If you decide to exercise the put, you have yet another set of
choices. You can put the money in your pocket (remember that you
effectively sold the stock for $80). Or you can buy the stock
back at the lower market price, if you like the stock and think
it makes sense for you. If the stock has dropped a lot, you
could conceivably buy even more shares than you originally
purchased.
This strategy isn't for everyone. And you shouldn't rely on this
article as complete and personalized investment advice for your
situation. But if you are investing money that you care about,
whether it is in a home, a car or a stock, you should take steps
to protect it. Which is why we should really talk.
With the market on defense, it makes sense to have some
protection for some of your prized possessions. If you'd like to
see how you could get some coverage for the stocks you own,
visit Mullooly Asset Management, at www.mullooly.net, or call
us, toll free at 877-223-7300.
I hear too many people say they're staying away from the stock
market, because it is too risky and you can lose a great deal of
money. Without measuring or knowing the risk, or a game plan in
place, you are almost certain to lose money. In my next article,
I'll share with you a strategy that can limit the amount of
money you lose in a stock, to a small amount. This approach can
keep you afloat in the market longer than trying your luck on
buying a single stock.