Best of the Week
Most Popular
1. Trumponomics Stock Market 2018 - The Manchurian President (1/2) - Nadeem_Walayat
2.Yield Curve Inversion a Remarkably Accurate Warning Indicator For Economic & Market Peril - Dan_Amerman
3.China is Now Officially at War With the US and Japan - Graham_Summers
4.Markets Pay Attention Moment - China’s Bubble Economy Ripe for Bursting - 16th Jul 18 - Plunger
5.Stock Market Longer-Term Charts Show Incredible Potential - Chris_Vermeulen
6.U.S. Stock Market Cycles Update - Jim_Curry
7.Another Stock Market Drop Next Week? - Brad_Gudgeon
8.The Death of the US Real Estate Dream - Harry_Dent
9.Gold Market Signal vs. Noise - Jordan_Roy_Byrne
10.The Fonzie–Ponzi Theory of Government Debt: An Update - F_F_Wiley
Last 7 days
Moving Averages Help You Define Market Trend – Here’s How - 14th Aug 18
It's Time for A New Economic Strategy in Turkey - 14th Aug 18
Gold Price to Plunge Below $1000 - Key Factors for Gold & Silver Investors - 14th Aug 18
Dow Stock Market Trend Forecast 2018 - Video - 13th Aug 18
Stock Market Downtrend to Continue? - 13th Aug 18
More Signs That the Stock Market Will Rally Until 2019 - 13th Aug 18
New Stock Market Correction Underway - 13th Aug 18
Talk Cold Turkey Economic Crisis - 13th Aug 18
Which UK Best Theme Park - Alton Towers vs Thorpe Park vs Lego Land vs Chessington World - 12th Aug 18
USD is Rising. What this Means for Currencies and Stocks - 12th Aug 18
Hardest US Housing Market Places to Live - Look Out Middle Class - 12th Aug 18
America’s Suburbs Are Making a Comeback - 12th Aug 18
Stock Market US Presidential Cycle, Seasonal Analysis and Economy - Video - 12th Aug 18
Yield Curve Inversion and the Stock Market - Video - 11th Aug 18
Land Rover Discovery Sport 1st Dealer Oil Change Service - What to Expect - 11th Aug 18
How to Setup Webinars and Use Them to Overcome the Barriers in E-Learning - 11th Aug 18
Big US Stocks’ Q2’18 Fundamentals - 11th Aug 18
Dow Stock Market Trend Forecast 2018 - 10th Aug 18
SPX Testing Its First Support Level - 10th Aug 18
Dreaming of a "Comfortable Retirement" on a Public Pension? - 10th Aug 18
The Forrest Gump of All Future Democrat Election Losses - 10th Aug 18
More Uncertainty as Stocks Got Closer to January Record High - 10th Aug 18
Gold and Silver Kill Zone - 9th Aug 18
Even More Cracks in the Gold Dam - 9th Aug 18
Ignore the Stock Market “midterm election year”, Which is “supposed” to be Weak - 9th Aug 18
Stock Market Trend and Volatility Analysis - Video - 9th Aug 18
Tips on Maximizing Small Serviced Offices Space - 9th Aug 18
VIX’s Collapse is Bullish for VIX and the Stock Market - 9th Aug 18
Vestles Platform Offers Several Key Trading Tools - 8th Aug 18
US Stock Markets Higher Until November 2018 - Part 2 - 8th Aug 18
US Stock Markets Higher Until November 2018 - Part 1 - 8th Aug 18
Stock Market US Presidential Cycle and Seasonal Analysis - 8th Aug 18
Is the Stock Market Correction Over? - 7th Aug 18
Yield Curve Inversion and the Stock Market - 7th Aug 18
Stock Market Elliott Wave Analysis and Forecast - Video - 7th Aug 18
Trade War! Win the Economic Hostilities Against the Chinese - 7th Aug 18
Technical Analyst Sees Silver as 'Oversold' - 7th Aug 18
Alex Jones Banned! Will Unapproved Opinions Be Censored Off the Internet? - 7th Aug 18
Gold and Silver Stocks On the Verge of the Next Major Decline - 7th Aug 18
First Time Buyers Need to ‘boost the affordability’ of Their Move Alone  - 7th Aug 18
Long Term Care Homes as an Investment are Heating Up! - 7th Aug 18
The Exponential Inflationary Stocks Bull Market - Video - 6th Aug 18
Land Rover Discovery Sport Oil Change Service Dash Warning Message - 6th Aug 18
Restructuring of Western Economic Power - 6th Aug 18
Stock Market Trend and Volatility Analysis - 6th Aug 18
Stock Market and Economy False Narratives That are Just Wrong - 6th Aug 18
VPN – Is It Worth It? - 6th Aug 18
All You Need to Know About Umbrella Companies - 6th Aug 18
Why China Lost the Trade War Before it Even Began - SSEC Stocks Index - Video - 5th Aug 18
Dow Stock Market Elliott Wave Analysis - 5th Aug 18
Iran's Rial Currency Is In A Death Spiral, Again - 5th Aug 18
IMF Produces Another Bogus Venezuela Inflation Forecast - 5th Aug 18
Gold & Silver Precious Metals Monthly Charts - 5th Aug 18
Time to Position for a Decade-Long Bull Market in Natural Resources - 5th Aug 18

Market Oracle FREE Newsletter

Trading Any Market

Bullish, But Nervous? Here's how to protect your Stock Profits - and make more...

Portfolio / Options & Warrants Dec 30, 2010 - 05:53 AM GMT

By: Money_Morning

Portfolio

Best Financial Markets Analysis ArticleBy Larry D. Spears writes: Since bottoming out in early July, the stock market has turned in a brilliant performance, giving many investors Christmas stockings bulging with profits. However, it also has left a lot of investors nervous - though not the ones that know how to use options.


Will a strong January Effect extend the market advance, which has seen the Standard & Poor's 500 Index climb 22.97% from its July 2 low of 1022.58?

Or, will further downgrades of European debt, high unemployment, a dismal housing market and other negative factors finally stall the rally?

Although many analysts are offering projections, no one can say for sure - but fortunately, you don't really have to know. By adeptly using options, you can both fully protect your existing profits if the bull stumbles, and play for more if it charges ahead in the New Year.

And, thanks to a holiday-related drop in market volatility over the past couple of weeks, you can do so at a very reasonable price. To verify that, you need only look at the Chicago Board Option Exchange's (CBOE) S&P 500 Volatility Index (VIX), which closed Dec. 23 at 15.45 - its lowest level since just before the market's top last April.

Normally, when one thinks of using options to lock in profits, the strategy that comes to mind is the purchase of a protective put, which will pay off should the price of the underlying asset fall sharply. However, a better approach - given current market conditions, volatility levels, and the time of year - is an outright call option "substitution."

It's a very simple strategy: You merely sell the stock on which you have profits you want to protect and buy an equivalent number of at-the-money call options on the same stock - at the money meaning the striking prices of the options are the ones closest to the actual trading price of the underlying security.

Here's an example.

Let's say you purchased 500 shares of CenturyLink, Inc. (NYSE: CTL) last July, shortly after it bounced off its 52-week low in sync with the broader market. You paid $33.50 per share, then watched the stock ride the autumn rally higher to a close of $46.40 on Dec. 27 (collecting a couple of healthy 72.5-cent-a-share quarterly dividends along the way). You thus have a profit on the CTL stock of $12.90 per share (or $6,450 on the full position) - a profit you're worried about losing should the market correct early in the New Year.

Here's how you could use a call option substitution to protect yourself, while saving the opportunity to add more gains should the stock price continue to rise.

You would simply sell your 500 shares of CTL stock, but maintain your long bullish stance by "substituting" the purchase of five at-the-money CTL February $46.00 call options (each call option controls 100 shares of CTL stock). The key features of the play are:

•By selling 500 shares of CTL at $46.40, you free up $23,200 ($46.40 x 500 = $23,200) in cash that you can use for other purposes (a benefit you wouldn't get with the purchase of a protective put).
•You capture the $6,450 in profit you currently have, ensuring you'll never give it back - no matter what the market or stock price does.
•With the February $46.00 calls carrying a premium of $1.40 (as they did on Dec. 28), you'd pay $700 ($1.40 x 100 x 5 = $700) of your profit to buy them and thus maintain your long position by controlling 500 shares of CTL stock.
•If the market does correct and CenturyLink stock falls back below $46.00 a share, you lose the $700 you paid for the calls - but that's all. You can't lose more, no matter what happens. (Note: If you dislike the notion of losing the $700 in call premiums should the stock pull back, simply think of it as equivalent to putting in a stop-loss order on CTL at a price of $45.00 per share. If you simply held the stock with that stop - a very tight one by usual standards - you'd lose the same $700 from current prices if it were triggered.)

•If the market doesn't correct, you begin adding to your already locked-in profits as soon as CTL stock moves higher. Because the $46.00 calls are already in the money, the premium will increase steadily - though initially not on a cent-for-cent basis - as the stock price rises. And, if you hold the calls until the expiration date - Feb. 18, 2011 in this instance - you'll capture additional dollar-for-dollar profits at any CTL stock price above $47.40 (the $46.00 striking price plus the $1.40 premium paid).
•Because CTL will report its fourth-quarter results before the options expire, you'll have full opportunity to capture any bounce in the stock price as a result of a positive surprise. But again, you can't lose the gains you already have should earnings disappoint.
•Should CTL stock trade relatively flat in January and early February, staying above $46.00 a share, you can re-examine the prospects for the company and, if you like them, exercise the call options. That would let you repurchase the actual stock in time to collect the next 72.5-cent quarterly dividend, adding another $362.50 to your gains on the 500 shares.
•Since it will most likely be the first week of January 2011 before you can execute this trade, you won't have to pay taxes on the stock profits you take for up to 15 months, giving you plenty of time to offset them.
This strategy will work for any long position on which you currently have profits (so long as options are traded on the stock), locking in your gains but letting you play for any continued advance.

Do be careful in choosing the expiration date of the call options you substitute, making sure they extend far enough out to benefit from the next quarterly earnings report and, if the dividend is worth considering, in ample time to qualify for that payout.

Source : http://moneymorning.com/2010/12/30/...

Money Morning/The Money Map Report

©2010 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules