In uncertain markets, every investor is fearful about possible losses in a stock portfolio. But other than getting out altogether, what can you do to eliminate that ever-present risk?
Here are two options strategies worth considering for portfolio management:
- Collar for loss prevention. The collar is a smart move when you are holding appreciated stock. Rather than risking a loss due to decline in market value, open a collar. This consists of a long out of the money put and a short out of the money call. Because both are out of the money, the options will be fairly cheap and you might even be able to create a net credit, meaning you get market risk protection without having to pay for it. For example, you bought 100 shares of stock @ $32 per share. The stock is currently price at $37. A collar could consist of a long 35 put and a short 37.50 call. This can be varied, of course, to get the desired net debit or credit. If the call is exercised, it creates a capital gain of $500 before trading costs; and by the way, if the call does go in the money, you can roll it forward to avoid exercise and to set up a higher strike. If the price drops below the put’s 35 strike, you can exercise the put before expiration and sell shares @ $35 per share, a profit of $300 before trading costs. If you think of the option trades as a single transaction, your net cost should be at zero or even a small profit. So exercising the put does not create a net loss in the option. The collar freezes your market risk and programs in profits with exercise of either option. However, it also places a ceiling on maximum stock profits if the stock price moves above the call’s strike and it is not closed or rolled.
- Protective put. The easiest of all is the purchase of one put for 100 shares. This can be a very affordable type of insurance, and it eliminates market risk below the net cost. For example, if you bought shares @ $32 and the put costs you a net of 0.70, your breakeven point is $31.30 per share. If the stock falls below that level, the risk has been eliminated. You can exercise the put and sell shares at $32, or close and take profits on the put.