Reducing Your Investment Risk. There are a number of things you can do to reduce your risk of loss if you invest in the financial markets. If you are lucky, you can hedge your bet and increase your income at the same time.. I have talked about this one particular technique several times over the 4+ years I have been writing this blog. The best way to illustrate this is to describe an investment I recently made.
I Recently Bought Some Intel. I won't go into the details of the due diligence I conducted before buying this stock. Let's just say it is a company that has lost value in the recent market melt down and has rebounded in subsequent months. A cursory examination shows that the company's earnings have rebounded more than the market price. For those who know virtually nothing about the company, it is the leading company in the production of computer chips which are used in everything from i-pads to elevators to automobiles. A few things I like about the company are as follows: It sells for 11.17 times earnings, much less than the average of the past 10 years. The earnings are growing at a rate of 11+% per year. They have 21+ billion in cash which they can pay out to stockholders or invest in attractive opportunities which may occur. This cash adds a measure of stability in a volatile economy. They pay a dividend of $0.63 per year which is around 3%, considerably more than you could receive on a savings account. Based on this information, this is ample reason to buy the company for a long term hold in my account. My opinion is that 3% yield and potential appreciation to a higher price justifies taking my money out of a money market account that pays virtually nothing and making the investment. Still, market volatility is such that i wanted a bit more insurance against loss due to market fluctuation.
Using Options To Reduce Risk. After buying this company at 21.07 per share, I sold an option which allows some one the right (but not the obligation) to buy the stock for me at $22 per share on or before the expiration date in mid February. For granting this privilege, I received $0.63 per share. While this doesn't sound like much, it is 3% of the 21.07 I paid for the stock. This means that the stock can drop from the $21.07 I paid to $20.44 and I will not suffer a loss. Instead of selling a 22 call, I could have had much more downside protection by selling a 21 call. Since I was relatively bullish on the stock, I wanted to participate in, at least, some of the upside if the stock increased in value. Does all of this sound like a lot of work for a small profit on a $21,000 investment? Look at it this way. I invested in a stock that I wanted to own. If the stock rises to $22.00 before expiration date, I receive an option premium of $.63, a profit on the shares of .93 and a dividend of .16. This is a total of 1720 on a $21000 investment, a return of 8% for 3 months or an annualized return of 32%. There are numerous other options for managing the investment. Looking at today's price of 20.7 for the stock and .21 for the option, I could terminate the investment for a very small gain of $47. If I just bought the stock alone, I could get out with a loss of $386.
Nothing Earth Shattering Here. You might be of the opinion that this is much ado about nothing and I would have a hard time disagreeing with you. On the other hand, now that I have a position in the stock, other opportunities will follow. If I stay in the stock and the price doesn't rise to 22 within the next month, I could keep the $630 option premium I received, get the dividend on March 1, and repeat the process again by selling another option. I will follow my policy of letting you know at major decision points what my management policy is. Hope it proves profitable and interesting.
Tragedy in Tucson. I always take it personally when someone kills a duly elected government official. In 1963, when John Kennedy was killed, I was heartbroken, not because I thought he was such a great president, but because, right or wrong, he was my president and an attack on him was an attack on all of us. I feel the same way about Ms. Giffords. The person who attacked her, and killed all those people, attacked us all. Some people may be able to forgive that but I certainly won't.
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