I can’t believe my stockbroker told me to do this…

My phone rang this morning and it was my stockbroker. He started to regurgitate everything I heard on the news the previous night. He was telling me how he believes that the market is overbought and that more than likely we are going to see a sell off in equities in the coming months. My stockbroker continued by saying how the financial markets are still seeing stress and more than likely we are going to see additional banks shuttering in the near future.

Now, I really don’t care that he is summarizing what he and I both heard the night before. What really irks me was what he suggested I do after he regurgitated the financial news. He suggested that I sell my equities and go into cash and wait out the market. I almost fired him for that comment. However, he and I are very close and I know he means well. Anyway, I had to back him up and explain that I would prefer to use the option trading strategies that are available to me.

He continued to express his position with what he was advising. I told him that there was no way I was selling any of my stock positions based on his fear of what the market may do in the future.

After much debate, I explained to my stockbroker that I was going to use an insurance policy to secure any downward movement in the market over the next 3 months.

How this option trading strategy works:

Anytime you are concerned about any downward movement in the market or an individual stock, you should purchase put options.

Let’s say you have a position in a great stock, but there is pressure on the upside, which in turn may drive owners into taking money off the table (sell their position and go into cash, kind of like what my stockbroker suggested). What you should consider is buying a put option for every one hundred shares of the underlying stock you own. This option trading strategy is like buying an insurance policy.

Purchasing put options allow the owner of the contract (the buyer) to actually put the stock to the seller of that contract at the strike price (or the predetermined price you are willing to put the stock to the seller of the put contract).

For example: Let’s say you own 1000 shares of ABC stock at $50.00 and there is news coming out about the company’s revenues and earnings. Now you are feeling a little unsure about the strength of the company, but think in the long term with the current management team and the superior product, you see the stock increasing in the future.

But, why risk a chance of bad numbers coming out of the company and dropping the value of the stock or why risk good numbers coming out and the stock increases and gets away because you sold your position too early. Why not purchase, in the case of this scenario, ten (10) put option contracts at $50.00. And let’s say those contracts cost you $3 per contract or $3000.00.

What this means is if the stock drops in value, you can put the stock to another investor (the one that sold the put option) at $50 and salvage most of your money.

The most you will lose is $3000.00 whether you sell the stock or keep the stock and let the option expire worthless.

The benefit of this option trading strategy is that the stock can drop to 0 and you will only lose the $3000.00 you spend to insure your position. But, if the stock increases to $53 you will be back at your breakeven point.

Not too bad of a risk position to secure your investment in your stock. Just imagine if you would have listened to my stockbroker and sold out your position and the next morning the stock opens up $5 higher.

This stock option strategy is great for insuring your stock position when you are not willing to sell or not wanting to sell.

Sure, there is a cost to buying your put options, but would you buy a home and not pay for home owner insurance? Or would you buy a car and drive around with no auto insurance? These are just some great reason and analogies when deciding next time whether or not to sell your position in a good or great company.

Here are some possible links of interest:

• InvestorGeeks » Blog Archive » Phil Town & INVESTools – I’ve become very interested recently in fellow investment blogger Phil Town’s site, and so I’ve been reading it from start to finish. After reading much of his site, I’ve come to enjoy his style of writing and investing. …
• Forex Trading Strategies – currency options – … out because right now, there’s a 50/50 split of bearish and bullish traders for the pound. So what do you do in these bearish/bullish instances? Well, there are a couple options trading strategies you can use to play both sides… …
• Options Trading Strategies – Book Review – Guy Cohen, The Bible of … – Options Trading Strategies – Book Review – Guy Cohen, The Bible of Options Strategies. Filed under: Wealth Building — Tags: Core Concepts, Option Strategies, Risk Reward — admin @ 8:02 pm. Clinton Lee asked: …

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