Thursday, March 28, 2013

Proof is in the PUTting.

So, for those of you who read my last post, your heads are spinning, or you completely shut-down, or you were moderately to considerably interested in my current investment technique.

Lets review:

I'm writing (selling) "naked puts".  Which is a contract (piece of paper with certain conditions and obligations if those conditions are met) which trades on the OPTIONS market.

This is not the "stock options" you have seen in the media that CEOs get.  (Or even Starbucks employees who choose to take a percentage of their pay in the form of company stock).

I'm not going to re-hash my previous post.  I'll just summarize what market conditions are required for them to work:

1. Market goes up = PROFIT
2. Market goes nowhere = PROFIT
3. Market goes down = PROFIT
4. Market tanks = potential to lose

Time exposed to market forces: 2-3 weeks.

The last statement is why I like them so much.

The hardest part about investing for novices (and even many seasoned pros) is getting hung up on wanting your holdings to "keep going up."  Some do, but many do not.

With these PUTS they EXPIRE automatically.  You have no choice.  They just disappear once their term is up.

So if you've sold a naked PUT for $100 and expires worthless, then you're done.  You have your money and you are no longer exposed to the position.  You can't hold on to it forever as they cease to exist once the contract is up.

This FORCES you to re-evaluate your holdings every time something expires.  So you're left with the choices: do I re-write a new contract and expose myself to market forces again for a while?  Or do I use that money to buy something for the long term?  Or do I just cash it out and do something pedestrian like pay rent.  You can of course go on a drunken bender too.  And I'm not one to judge!  Just don't trade drunk!

Now what do I mean by the "potential to lose"?

Say company ABC is trading at $10 per share.  You've rushed out and SOLD 1 contract for a 1 month PUT.  It has a strike price of $9.  When you sell, you get to keep the premium and in this case lets just say the contract is listed at $1.  Seeing as options are listed in price per share, but correspond to 100 shares, it means you get $100 minus your trading commissions for selling 1 contract.

If ABC shoots up in price, the value of your put will rapidly decline in price.  (This is what you want!  You have to BUY IT BACK if you close it out early)  If it stays this way until the option expires, it will expire with a $0.00 value.  So PROFIT.

If ABC just flat-lines for the month, the contract will again expire worthless and you keep your PROFIT.

If ABC falls a bit due to lousy sales, it can fall as much as 10% in value and your PUT will AGAIN expire worthless.

If ABC however falls more than 10% or even goes bankrupt, then you're on the hook for $900 + trading commissions and the "assignment fee" which is often as much as a "phone-in" order.

What happens if it falls beyond your strike?  You take ownership of the shares first day after the market opens AFTER the contract expires.  Your price is the strike price.

I hope this helps somebody!

Stay hungry my friends!

No comments:

Post a Comment