A fact of life is that emotions can wreck the boat in trading! Could they also help keep the boat afloat? There are a variety of four-letter-words involved: FEAR, HOPE, RISK, RICH, POOR, EDGE, SELF, EXIT, PLAN, SIZE, TOOL, GOAL, TASK, GAME, LOSS, WINS, NEWS. Which ones are the critical ones for us? I find goal, wins, and size the most critical ones for me, with the others taking their place within these three. How could I have a goal if I was not thinking of creating wealth (RICH) by monitoring my RISK, and seeking a high probability trade through TASK on my list of action. Can I create a WIN without an EDGE, and appropriate TOOL for my GAME? What SIZE is the best for me? I want to prevent a LOSS by utilizing a PLAN, and observing an EXIT in the right place. I am not seeking to FEAR the market, or win with HOPE. Although I included the word NEWS in this group of four-letter-words, I wish that it was not what was driving the equities up or down in price!
Adding options to my trading tools has created a control on my emotions. My equity-only-portfolio lost a huge amount of value on a sell-day. For a number of years, I invested in long equity only and now recognize that my risk was quite large. (Do you think that was the result of the aging process or the changes in the stock market?) In my search for insurance, I found that “options” is the appropriate policy.
The market is in a Correction at this point, which leads me to consider engaging in protective positions. For this article, I’ll look at a favorite stock and the protective put to apply to it. I’ll provide the intermittent steps to demonstrate the control of emotions through the process.
Facebook, Inc. (FB) was introduced to the market on May 18, 2012 at $38.00 per share. On opening day, it priced as high as $45.00 per share and then sold off. It was not a profitable IPO as it engaged in a downtrend for many months. It hit its all time low on September 4, 2012 at $17.55 and closed the year at $26.62. The question is, “How many of you would hold this equity for that period of time through a drop of more than 50%?”
I do not jump into a new equity on its initial offering day. There have been those that soared and made me “wish” I had generated a profit from a decision like that, but there are also others, like Facebook, that do very poorly for a period of time. I enjoy reading articles on Facebook and the CEO, Mark Zuckerberg. It does not surprise me that this equity has a massive amount of volume in the US Stock Exchange. The average daily volume is over 72 million shares. In late February of 2014, the price on FB was over $70.00. The base structure was “extended” beyond the 20-25% move off the buy point of $54.93. I would enjoy holding the equity in my account, but the fair-market-value was more than I wanted to pay. What would happen if I bought the long stock and the long-term, long put?
+100 shares @ $70.00 = $7000.00 (plus fees; although I plan to omit this added expense from here)
1 Jan 2015 LP 70 @ $11.79 = $1179.00 (The LP gives me the “right to sell” the equity at the strike price at any time between purchase and expiration, for a loss of 14% of my capital invested.)
Total Debit = $8,179.00
FB has been moving down in price since that time. The equity went as low as $54.66 during this time lapse (a drop of more than 25%) but had “found bottom” and is making a new Stage 3 Base.
What choice would I face if I entered a long-term-put-calendar spread?
1 Jan 2015 LP 70 @ $11.79
-1 Mar 2014 SP 70 @ 1.94 (The short put, SP, makes me “obligated” to buy the stock at the strike during the period between entry and expiration.)
Net Debit = $1179 – $194.00 = $985.00 (about 12% of the investment needed v. the long equity as a purchase)
Roll the March short put to April 70 for added credit of $2.10. Roll to May 70 for $1.50 credit, and again to June 70 at $0.14 credit.
Currently, the cost basis for the put calendar spread is the following:
$11.79 (debit) -1.94 (credit) -2.10 (credit) -1.50 (credit) -0.14 (credit) = $6.11 x 100 (per contract) = $611.00
What could happen to this position of mine?
Close the entire position for a profit
Roll out the short put again for more credit
Allow the short put to assign the stock to me, where the position will change from a Put Calendar Spread to a Protective Put spread.
One of my favorite benefits of having added Options to my trading style is the capacity to “protect” my investments with long puts (or other spread trades.) One lesson learned is that the stock market goes UP or goes DOWN. Being able to benefit from the use of options, as well as equity shares, puts me in a position to feel safe and sound, and disregard any of my EMOTIONS!
Emilu Bailes
OptionsANIMAL Instructor
