THE INTELLIGENT BUT WORRIED BULL

Markets Rise; Markets Fall

When it comes to stock investing, one of the most accurate predictions remains: "Markets have their ups and downs." Sometimes the bulls win and sometimes the bears win.

One of the sad truths is that too many individual investors unload their holdings after a significant decline, missing out when the decline ends a a large rally ensues. Although good advice  (If you are an individual investor, do not try to time the market when investing for the long term) is easy to come by, it is understandable that people become frightened during market downturns.

When they lose enough, they sell everything, trying not to lose their remaining assets.

Options to the Rescue

If you have ever succumbed to that vicious trap, or if you are thinking about dumping investments to provide more security for your remaining assets, please reconsider.

Options -- the conservative and versatile investment tool -- can help you avoid making decisions that result in a financial catastrophe.

If you are a long-term investor (short-term traders have a different mindset and a different trading style) who occasionally thinks in terms of owning safer investments that come with built-in insurance against a huge loss, then options can be your salvation. But please understand: Options must be used wisely to achieve the peace of mind that comes with safety.

Option Strategies for the Bullish (but Frightened) Long-Term Investor

·     Very aggressive technique that allows you to remain fully invested, but which protects the entire portfolio. NOTE: "Protects the entire portfolio" does not mean that you will never lose money. Instead it means: If you pay a premium -- just as with an insurance policy -- then all losses become limited to a predetermined (and hopefully acceptable to you) sum. In other words, a stock market tumble will result in a monetary loss, but your portfolio will survive.
You can achieve these results by choosing either of the following plans:

1.       Buy put options. Either buy one out option for each 100 shares of stock in your portfolio. Or buy enough put options on the S&P 500 Index (SPX) to cover the majority of your loss when the market tumbles. This only works when your portfolio is highly correlated with the index whose puts you buy. 

2.      Replace each 100 shares of stock with one longer-term, high Delta - in the-money, call option. You can never lose more than the cost of the option, limiting losses. The cost of this protection is the time premium (i.e., the part of the option premium that exceeds the option's intrinsic value) paid for your options 

·         Limited protection method that cost zero out of pocket  cash (instead you to collect a cash payment), but which limit your potential profits. That is no small sacrifice for the investor who is truly bullish, but is very attractive to the investor who is looking for the market to rise rise.
The best way to adopt this plan is is sell (write) one call option for each 100 shares of stock owned. This strategy is knows as covered call writing.
An equivalent strategy that can be applied when investing new cash into your market portfolio is the naked sale of put options. The risk/reward is the same as writing covered calls, when the strike price and expiration are identical. 

The bottom line for the intelligent investor is that there are simple option strategies that can be used to accomplish two things: First, you remain invested in the market, participating when markets rally. Second, you have protection for all, or part, of your investment portfolio -- just in case a bear market emerges.