Buying PUT.

[squiffy]

I take back all those mildly nasty things I said about QUANTS. Someone suggested buying a PUT to provide insurance against a catastropic collapse in the price of my ODP shares. But I would appreciate some quick confirmation of how to do the calculations. I need to determine how much it would cost, say to provide downside insurance for the first three weeks of Jan. 2004.

I assume PUTs expire on the third Friday of the month or something like that.

I have 12,795 shares of ODP which I bought at an average price of 15.76. Currently trading at 16.51.

Can someone suggest a strike price for the Jan. 2004 covered put and help me do a rough calculation as I have never bought a put.

I use Ameritrade, so if you are familiar with their costs that would help. I guess it is a certain price per contract, with 100 shares per contract. Plus a certain price per share.

And I am not sure what strike price to buy at. Probably 15, but not sure.

[Ray Zee]

why on earth would you want to hedge your bet here. you put way more of your bankroll into this thing because you want action. so take the action and satify yourself. if you want some reasonable amount of investment security you need to sell alot of it and diversify your holdings. you are an accident waiting to happen. good luck and hold on the ride is starting for you.

[squiffy]

Once you make a risky move. Figuring out how to reduce your risk is a separate question. Selling is one option. Buying a put may be another option to consider, which I had not considered before.

But I need to know the cost of the put to figure out if that option is worth it.

[squiffy]

As far as I can tell, buying a put would be much too expensive. Which is why I am wondering about my calculation. I will try to call Ameritrade when the trading floor is open. The general account services people aren't too knowledgeable about options.

It seems to be 10.99 + 1.50 per 100 share contract plus about .20 per share at a strike price of 15. But that gives a costs of 10.99 plus 21.50 per thousand shares, or about 2590.99.

If that calculation is correct, the put is way to expensive as it would take away most of my 8,000 to 9,000 profit from holding the stock in the first place.

My problem is I have heard and read that options are one way to reduce your risk. But I simply have never seen a situation where an option has seemed to be worth it.

So I am wondering why people would use them to hedge risk, when it appears that the cost is prohibitive.

A second problem is the Ameritrade person reminded me that I cannot buy a put in my retirement account and about 7,000 of my 12,000 shares are in my retirement account.

So you may be correct that if I want to reduce risk, I need to sell some shares of ODP, which I generally agree with. But wanted to see if options are feasible as someone mentioned them and I have read a little bit about them.

On the related topic of covered calls, whenever I have bought a stock which I thought was undervalued, it has never made sense to me to sell a covered call, because it has always seemed to me that I am selling a huge upside, which the call does not properly value, which is why I bought the stock in the first place.

My friend keeps harping on how a covered call can be a sure gain over the short term. But you still bear the risk of the stock giong to zero. And you sell too much of your upside.

Anyone here have some experience with using options to hedge risk? Can anyone provide a simple real-life example using a real stock and real option prices to show that it might be worth it?

[Ray Zee]

no one can show a situation where it is worth it as the price of the option is fairly priced. so you get what you pay for plus commision. you need to sell to lessen your risk. or short against the box. this way you wont have the time decay to worry about.
your out on a plank with a blindfold on guessing where the end of the board is. the sharks are down below.

[adios]

First issue is what kind of account you have with Ameritrade. To be honest I don't know what Ameritrade's rules are in a retirement account but I'm assuming this is not a retirement account we're talking about because I'd assume you'd just sell if you wanted to insure against a catastrophic drop in a retirement account /images/graemlins/smile.gif. Therefore I'm assuming you're not selling due to tax reasons in a taxable account. First of all your account has to be such that you can trade options. If not you'll have to have your account upgraded ASAP which shouldn't be hard. The idea is to buy puts that are "in the money" i.e. trading at intrinsic value with the stock price to lock in your price. In your case the 17.50 strike price for the puts would do the job. You'll have to pay a commission and option transaction costs are typically high.

The other alternative is to "short against the box" to lock in your price. Shorting against the box merely means opening up a short position for the same number of shares you're long ODP. My understanding is that there are tax ramifications with shorting against the box. Don't know for sure if that's true and if true don't know what the tax ramifications are so you need to investigate that further.

All in all I'd probably just sell, pay short term capital gains taxes, and move on.

[mrbaseball]

I just pulled up ODP on my trade screen. I trade stock options and commodities for a living.

Jan options expire on Jan 17th. ODP Jan 15's are dirt cheap with a .05 bid at .15 offer. Commissions will cost you more than the options themselves is my guess. But you need a big move down to get to the 15's so 17.50's probably a better choice. They are currently .95 bid at 1.05 offer but offer real downside protection as they have about 90 cents of intrinsic value. So the time premium is similar to the 15's at 10 to 15 cents.

You could always sell in or at the the money calls too which gives better but more limited downside protection. I say better because you collect rather than pay the time premium. But this gives you less catastrophic protection yet better return with no catastrophy. Also has the risk of your stock being called away.

Or you could just slim your position down. Options can greatly increase your bottom line while reducing your risk if you have few barriers to entry (ie low transaction costs) and a good understanding of how they work. But for most "typical" people the barriers to entry (ie transaction costs) make options a bad option and not worth the trouble.

Pick a price and put in some stops. If it breaks you're out. So long as it isn't an overnight gap move anyway.

[RocketManJames]

You have incentive stock options at a publicly traded company that do not fully vest until late 2004. These options are very deep in the money now, but you believe that the company is overvalued at these prices. You can purchase 2005 LEAP puts to lock in profits.

As Ray Zee mentions, options are generally fairly priced. But, it does depend on the model you use. The two common pricing models for options are Black-Scholes and Binomial. The Philadelphia Options Exchange website can show you the theoretical values of options using B-S, and you'll see that often it is not the same as the market price.

Another real-life example of using options. You own stock in a very high-risk pharmaceutical company. It is going to either get FDA approval or not in the next 2 months. If it gets approval, you believe the stock will move up modestly (say 5%) or remain unchanged. If it doesn't you believe it will plummet 30-40%. You do not feel that this is likely, but it is certainly not out of the realm of possibility. Additionally, your cost basis is quite low, and you'd much rather hold it for much longer-term and allow compounding of your investment without taking an immediate tax-hit. In this situation, it might be interesting to purchase puts to protect your position (this costs money), but sell covered calls to offset the expense of buying the puts. Note that you do NOT expect the stock to move up substantially with approval, but you DO expect the stock to crash if it is not given the FDA approval. Not saying this is the best way, but if selling the stock outright is not something you want to do, then this is at least an alternative.

-RMJ

[mosta]

the main problem with options for the retail investor is that you get viciously raped on commissions (on top of all the other inherent risks). I'd recommend Interactive Brokers for a buck a contract (this isn't a tout, as I'm competing against Timber Hill in the pit). other discount brokers may match that but I don't think I've heard better.

another way of decreasing your exposure (comparable to "selling against the box" I guess) would be to short single stock futures, though they may not list this name.

I'd buy-write the stock before I'd buy the jan 15 put, unless you think there's significant chance the stock may take big dump in that short time range. the call doesn't protect you as much, but it's better than naked long, and gets you something, which the put probably won't.

Better yet, how bout the Feb 15/17 risk reversal (buy put, sell call) for a nickel credit (buy .30, sell .35)? When you got in the stock were you playing for a gigantic upward move (I don't know whether this is a news/event stock), or just a better than average gain. If the latter, the risky seems ideal to me--the nickel may even cover all your commissions.

[RollaJ]

Hope you bought those puts /images/graemlins/shocked.gif

[squiffy]

No. Lost back my entire $10-$12K gain over the last 2-3 days. Should have sold after all. Will now have to hold until end of Feb. or March and pray for a recovery.

I am back to even again, where I started in Sept. 2003.

[Redsox]

You should probably read up on the way that options trade and are priced before even considering trading any options in your own account. I've been a specialist on an organized exchange for a few years now, and the best book for practioners is probably "Options Pricing and Volatility" by Sheldon Natenberg. There are a dozen considerations that go into the pricing of an option that you're probably not even thinking about (volatility, dividend payout, skew, interest rates). It will be much to your advantage to look into the inner-workings of both the way options are priced and the way which they are traded on the floors of organized exchanges in this country. Lastly, make sure that you figure out why you want to trade options against a holding, i.e. why you wouldn't dump the stock if you think that its going to go down? There are significant issues with trading options for the retail investor. Make sure you know what you're getting into.
-Eric

[FredJones888]

"As far as I can tell, buying a put would be much too expensive"

you got it and thats all you need to know. If you are really worried about this position you just need to reduce it or dump it altogether. What you need is some kind of sell discipline. A monkey can throw a dart at a wall street journal and pick a stock, but it takes a thinking human ( or an automated system ) to figure out when to sell. At what point did you want to sell?

[RollaJ]

[ QUOTE ]
Will now have to hold until end of Feb. or March and pray for a recovery.

[/ QUOTE ]

Wow, if I had $1800 for every time I said that......... I think I'd be even /images/graemlins/frown.gif