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Irrefutable Testament To The Value of Put Protection

Patrick Ceresna
October 29, 2014
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4 minutes read
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First off I wanted to say thank you to all the Toronto Options Education Day attendees for a warm welcome, it was a pleasure to meet all of you. Recently the stock markets have increasingly become volatile as almost all Canadian sectors have gone through a healthy profit taking cycle. This gives us the opportunity to reference back to our prior blogs where we demonstrated the use of puts as protection.

For those who are new to put options – every 1 put option purchased on a stock represents a contractual right to be able to sell 100 shares of a stock at a specific price over a specific period of time. When used as protection for investors owning stocks, it offers the ability to create certainties in an ambiguous market.

Looking back to August 29th. I wrote a blog titled “Is there any Fuel Left in the Energy Sector Bull Advance?” In that blog we referenced the substantial divergence between the price of crude oil (and natural gas) in relation to the material advance in energy stocks. I felt this created an increasing vulnerability to owning the shares and presented an example using Imperial Oil(TSX:IMO).

We could not have been more right. The time of the blog marked the highest price Imperial Oil traded before a substantial decline of over 15% (close to $10.00 a share). In that example we purchased an October $56.00 put option (secured the guaranteed sale price of $56.00 for the shares). I wanted to demonstrate the value the insured investor received vs. the traditional buy and hold investor.

Investor 1 – Buy and Hold

In this example the investor owned 1000 shares at an average cost of $45.00. At the time of the blog the stock closed at $57.50 which saw the investor up 28% in paper profits. On October 17th the stock closed at $51.45 which saw the investor lose half the profit down to 14%.

Investor 2 – Bought the October $56.00 put as protection

In this example the investor owned 1000 shares at an average cost of $45.00. The investor was also up 28% in paper profits on August 29th but that investor spent the $0.75 to buy the October $56.00 put protection. On the October 17th options expiration the put option was $4.55 in-the-money ($56.00-$51.45). This allowed the investor to close the put at a net $3.80 gain ($4.55 – $0.75 cost). The gain on the put allows the investor to have a new adjusted average cost on the shares of $41.20 ($45.00 – $3.80). This means that at the $51.45 closing price and a $41.20 new average cost, the investor is still up 25% on the stock, in spite of a violent $10.00 decline from top to bottom in the 2 months of the trade.

The key take away is the investor protected themselves, managed risk, locked in gains and substantially reduced the volatility of their portfolio. Who says options are risky now?

In my opinion, investors taking the time to educate themselves on options as an investment tool is one the single most important things one can do to improve the chances of long term success.

Patrick Ceresna
Patrick Ceresna http://www.bigpicturetrading.com

Derivatives Market Specialist

Big Picture Trading Inc.

Patrick Ceresna is the founder and Chief Derivative Market Strategist at Big Picture Trading. Patrick is a Chartered Market Technician, Derivative Market Specialist and Canadian Investment Manager by designation. In addition to his roll at Big Picture Trading, Patrick is an instructor on derivatives for the TMX Montreal Exchange, educating investors and investment professionals across Canada about the many valuable uses of options in their investment portfolios. Patrick is also co-host to the MacroVoices weekly podcasts. Patrick specializes in analyzing the global macro market conditions and translating them into actionable investment and trading opportunities. With his specialization in technical analysis, he bridges important macro themes with the attempt to understand when those trends are beginning and understanding where they likely to go. With his expertise in options trading, he seeks to create opportunities that leverage returns, while managing/defining risk and or generating consistent enhanced income. Patrick has designed and teaches Big Picture Trading's Technical, Options and Macro Masters Programs while providing the content for the members in regards to daily live market analytic webinars, alert services and model portfolios.

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