Opinion: Don’t Panic II

(Part I)

Portfolio Insurance

Options
can be used to insure the value of a stock portfolio just as you insure
the value of your home, car, or life. Depending on the specific option
strategy chosen, such insurance can cost nothing.  That's right – the
investor can be insured against substantial losses without paying a
cent –
and in many cases, you can be paid a cash premium to obtain that protection! 
But the insurance is not totally free.  In return for protection, the
investor must accept a limit on the potential profits that can be
earned.  The collar
strategy accomplishes that.  If you are unwilling to sacrifice
potential profits, you can still use options as insurance.  But, it
will cost cash. 

One
of the problems with options is that the strategies have names that
sound confusing, such as 'collar' or 'iron condor.' Once you learn how
to adopt those, and other strategies with limited risk, you'll see that
they are not complicated after all.    I truly believe most individual
investors are capable of managing their own portfolios by creating
their own hedge funds and adopting risk-reducing investment methods.

Spread the Word

Over
the past six years, I've been preaching the idea of hedging an
investment portfolio by adopting methods that use stock options.  I've
suggested the idea to dozens of financial journalists, suggesting that
they consider helping their readers learn about using options
conservatively.  For the most part, my messages were ignored.  Only
three showed any interest by engaging in serious telephone and e-mail
exchanges.  Two  were very interested in learning more about how their
readers could benefit from using options, but in the final analysis,
neither told the options story.  And I don't blame them.  Options are
not well understood by the masses and it's next to impossible to
provide more than a superficial explanation in a newspaper article or
column.  Journalists must

be vigilant and not promote unsound investment ideas to their readers. 
Sadly, options are considered by many to be 'too risky' for the average
investor.

I've
done two radio interviews with hosts who were interested in telling
listeners about options, but there were many background issues to
discuss and the time went quickly.  The interviews were interesting to
listeners (I've been told), but there was insufficient opportunity to
offer any meaningful education.

This week, I had a better experience.  I was interviewed by Kevin Cook at the Option News Network. 
He's a fan of my writing and during the short interview we talked about
how investors can learn various conservative option strategies. (I'll
add a link to the interview as soon as it becomes available).

The Rookie's Guide to Options (a free sampler e-book is available) is the newest and most comprehensive of my three books.  I've received great feedback on the books and know that I've helped investors learn to use options intelligently. 

Blog

There's
also plenty of 'meat' available on this blog and at mdwoptions.com. 
That material may be sufficient for some readers to obtain all the
information needed to begin an options trading career.  But, others may
require further reading, and for them, I recommend The Rookie's Guide
to Options.  There are other sources of information and I encourage you
read and find one or two strategies that you fully understand – and
which allow you to be comfortable with the risk/reward profile of your
portfolio.  Then practice in a paper trading account before using real money.

The
main purpose of this blog is to reach stock market investors –
especially those who have little, or no, experience with options.  My
daily posts are directed to you.  I try to provide commentary, specific
advice, and educational material to help you get started using
options.  The one point I stress repeatedly is that long-term success
depends on your ability to manage risk.  You'll make plenty of profits
along the way and you'll also take some losses.  To be a winner, you
must keep those losses under control and use methods that suit your
personality and investment objectives.

You can
easily learn to use options as risk reducing investment tools.  Wise
investors can ignore the gambling aspect of options and use them as
they were intended to be used when invented (centuries ago): to reduce
risk.

The
blog and website are here for you to use, and there's no cost.  Help
yourself, and if you agree that it's helpful, please recommend this
blog to others.

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4 Responses to Opinion: Don’t Panic II

  1. Mike S. 09/20/2008 at 3:48 PM #

    Hi Mark, I have a couple of questions. First, a lot has been written that over 700 financial stocks cannot be shorted. (I love how they changed the rule in the middle of the night). My question: Can we still buy puts on those same stocks? In other words, people who still want to short might have to turn to options.
    Second question: I bought puts on FXP and it was up over 1000 percent with a wide bid ask spread. I panicked and sold it at the bid, and although I made a substantial profit, the option went up another 4 points after I sold. Should I have just waited when I saw such a wide bid ask spread? I was worried the market was going to reverse so I locked in my profit, but in retrospect, it was not an ideal move. How would you have played that?
    Thanks!

  2. Mark 09/20/2008 at 5:02 PM #

    Hi Mike,
    1) You may buy puts.
    2) You may exercise those puts to go short stock. Your broker may not have any stock to lend you and that would force you to cover the short, but that’s not what you asked.
    3) When you see such a wide bid/ask spread, unless you are desperate to trade within the next 5 seconds, enter the order in between the bid/ask and then change it, as necessary. If there is no volume, then it’s just you and the market makers. But, if the option is trading, then investor bids and offers appear all the time. Be a bit patient. But – don’t be stubborn.
    Example: If the market is 12 – 17, enter the sale at 14.5, then lower it to 14 after a few seconds. Then keep reducing by one half point – but increase the amount of time you wait before lowering it again. If there is any order flow, you have a decent chance to sell above the bid.
    If the option was trading at a high price (as I assume your was), and the market is 60-70 – then it may pay to panic a bit. After all, the bid could go from 60 to 50 in a hurry. Still, I’d try 62 before I hit the 60 bid.
    4) You cannot always sell at the high. You know that. Congrats on a 10-bagger.
    Mark

  3. John Heppsy 09/22/2008 at 10:04 AM #

    Mark,
    Great blog! I lost a lot of capital last month on NDX PUT 1650/1600 spreads. I had moved them from 1750/1700 down to that level. I closed the spread when the NDX was near the 1630 level (At thatr point the theta decay would make the spread lose further as opposed to helping)
    I’m looking for a clear example of how you could use cheap FOTM puts to hedge or offset losses.
    I heard one person say to spend 10%-30% of the premiums you gain from selling the spreads to buy the hedge. How far in advance should the hedge be purchased? Do you purchase puts that are farther OTM than the spread you sold?
    Up to this point I have made ~3% on average per month with iron condors with far out strikes. Any insight would be greatly appreciate.
    Than you in advance!
    John

  4. John Heppsy 09/22/2008 at 10:10 AM #

    Or maybe, what iron condor could you establish today for a 2-3% premium earned that is properly hedged against a black swan event?
    John