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Use Options to Ease the Pain of Rising Gas Prices

Will increased gas prices turn 2012’s bullish run into another 2011?

The market continues to creep higher in 2012 in spite of news-driven headwinds. It feels refreshing, yet something feels amiss.

There have been several comparisons over the past few weeks to last year’s rally. The year 2011 started off very strong with the S&P moving from 1257 at the start of the year to 1370 by May 2. This year has seen the S&P move from 1257 (eerily the same number) to a high on Friday of 1374. The fearful comparisons being drawn are what happened to the S&P from May 2 until Oct 4. This time period saw the overall market average drop 21.6% to 1074.

The similarity between the market movements in 2011 and 2012 has made many investors pause and question whether this rally is for real. Higher oil prices, weakness in Europe and uncertainty from China are all on the table this year as well. Gas prices have seen a spike this year that have many worried about the impact on the economic recovery. Many consumers will be affected negatively by an increase in gas prices. Consequently, we could see a slowdown in the recovery.

The biggest difference between this year and last year is jobs.

Last year at this time, the non-farm payroll number was not impressive. We were struggling to add jobs to an economy in dire need. The GDP indicated we were officially out of the recession, but for many, it didn’t feel like it. Although we still have a long way to go to pull out of this recession, this year’s comparison is different. We have already had two solid employment reports this year. We are adding jobs in 2012 at a relatively brisk pace. If we continue to add jobs with the upcoming non-farm payroll number on Friday, this will mark a huge difference for 2012 in comparison to 2011. Jobs are the critical piece to our long-term recovery.

So, is the market going to be bearish or bullish?

Friday may hold the answer when we get the monthly figures from the Labor Department. We’ll be discussing this report further in our weekly trading show at OptionsANIMAL.

So how do I trade this market?

Hedged.

There was a great interview with PIMCO CEO Mohammed El-Erian at the beginning of last week on CNBC. In his interview with Squawk Box, he was asked what investors should do in markets which are bimodal such as this, with a potential move in one direction or the other.

He answered, “Having a claim on the upside and a hedge on the downside.”

For many investors, that may make sense, but I am sure that many investors scratched their heads and wondered what he was talking about.. Let me explain one simple strategy that accomplishes this type of positioning in the market.

This application is called a protective put or married put, and is done every day in the markets. Let’s look at an example.

By definition, a married put is an options strategy, whereby an investor, holding a stock position, purchases a put position on that same stock to hedge against a decline in the value of the stock.

Let’s say you purchased shares in XYZ corp. at $50/share. The company has their quarterly earnings report in a few days and, as a form of insurance, you purchase a $50 Protective Put. This allows you to sell the stock at $50, regardless of the price of the stock. If the company were to announce bad news and the company’s stock price dropped in value to $30/share, the protective put gives you the right to sell your stock at a fixed price within a set time frame ($50). You have the right to exercise your put option and get rid of your stock.

This certainly beats the old buy and hold strategy with a stop-loss for protection.

For me, knowledge is power. This does not just involve access to streaming news and data that helps drive my investment decisions, but also knowledge of strategies that can be applied to take advantage of whatever the markets give me.

Greg Jensen
OptionsANIMAL CEO and Founder

Read more: http://community.nasdaq.com/News/2012-03/use-options-to-ease-the-pain-of-rising-gas-prices.aspx?storyid=125289#ixzz1oMXQh5v5

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Greg Jensen

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