Stock Forex

One last use for options is a “hedge.” A hedge is like an insurance policy. You hedge to limit your downside.

Let’s say you just spent $10,000 and purchased 100 shares of stock at $100 each. You think the stock is low (either the company is really profitable or that the stock has gone down — hit a low). That’s a lot of money to have tied up. You have unlimited upside potential and all the time in the world because you actually own the stock. Your only risk is a dip in the price of the stock.

To ensure against a loss in your stock value, buy a $100 put, or even a $95 put (if you are willing to lose a little). Yes, you could put in a stop loss, at, say, $97 and only lose $300, but what about a drop to $70 wherein you could lose $3,000. The $100 put is, say, $2. One contract (controlling 100 shares—the same amount you own) would cost $200 plus commission. If you never exercise the put, that’s $200 out the window. You bought the stock hoping it would go up, and if it does your $200 ($2 put) goes down in value. Any increase in the value of your $10,000 investment will be offset by this loss. However, if the stock goes down, and I mean seriously down, this $200 will be money well spent. If the stock goes down to $80 (assuming this is still before the expiration date of the put) your put will be worth at least $20. It could be $22 to $25 depending on any time value still built into the put premium.

Think of this. You could sell the stock for $80 and also sell the put premium for $20. That’s $8,000 and $2,000 respec­tively. You’ve broken even. You see the insurance-against-loss aspect of this. You could lose $200 or at least have your profits offset by this amount, but you can make up all your losses with the proper put.

Two more ideas: the $95 put might be purchased for 25tf when the stock is at $100. One contract would be $25 plus commissions. This lower strike price and the corresponding lower put premium will let you buy a put further out (say 5 to 6 months) for a lower price. Your risk is $500 plus the put premium. Why $500? Because you’ve lost the amount between $100 for the stock and $95. 100 shares times $5 equals $500.

The $100 put is $2 and it’s only out one to two months. I usually buy the short term puts at the higher strike price (out one to two months and then reevaluate the situation: com­pany news, the stock price near the expiration date, et cetera) or further out puts below the strike price. They’re cheaper but also give you more time.

By looking at the company’s chart you can determine how much you want to spend, how much time you want to buy, and how much risk you want to hedge.

Combo

You could also buy a call with a $100 or $110 strike price. If you’re certain this stock is a winner, go ahead and buy the stock for $10,000, but spend $500 and purchase the $105 calls out two to three months. If the stock rises, you’ll see first hand how the riskier option plays produce the greater returns.

By definition, a straddle is writing (selling) a call option and a put option on the same stock with the same strike price and expiration date. In the sameness is the simplicity. The same stock. The same number of contracts (call and put). The same strike price. The same expiration date. Notice that I am selling both a call and a put, which generates money into my account from both sales. Though it is not exactly doubling my cash in, it does come close to doing that.

There are some potentially expensive risks, however. This is not a strategy for everyone. If the stock suddenly makes a big move in either direction, I could be caught. Remember, I haven’t bought any stock and I have sold someone the right to force me to sell the stock to or buy stock from them.

If the stock goes up and I get called out, I will have to buy the stock (in order to sell it). Since the stock went up, the person who bought the put option (who was betting that the stock would go down) is not likely to exercise his or her option. This is because he or she can sell their stock for more on the open market than they could force me to buy it for. The put option will expire.

If the stock goes down or stays under the strike price, I don’t have to worry about being called out because the person who bought the call option from me can buy the stock on the open market for less than they would have to pay if they exercised the option and bought the stock directly from me. The person who bought the put, however, can force me to buy his/her stock for the option price.

This is not a loss. I am simply paying more for the stock than I might have. What I get when I sell the stock will determine whether I have a gain or loss. The money I received from selling the options will offset the difference between what I paid and what I sold the stock for.

Before I write a straddle, I spend a lot of time with my broker evaluating what the cash flow will be and what the risk of loss could be. I won’t typically write a straddle unless the risk potential and the cash flow is substantial. You’ll need to make your own decisions in this area. Most of the time, the stock stays close to the strike price and both options expire leaving me with all the money. Occasionally, one of the options will be exercised and I’ll have to give back some of the premium I received from selling the options, but I get to keep most of it.

You can’t always tell where the your business is going without any help from the experts. You could use forex trading signals to help you make the right decisions.