In regards to bearish option strategies, I want to focus today on put options. Puts
give the buyer the right to sell the stock at a specific price (known as the strike
price) up until a defined date in the future (the expiration date). Here's both a
short-term as well as a longer-term technique to play the downside with puts.
Strategy #1: Short-Term 'In-the-Money' Options
Let's use an example where you like hypothetical stock XYZ's outlook over the next
month. You think the stock should move down from the current price at 53 to 44 over
the next month. If you shorted the stock, 100 shares would be sold at $5,300
(commissions are excluded in these examples for ease of comparison - you typically
have to pay a commission whenever you enter or exit a stock or options trade). In
contrast, you could buy 1 option contract that gives you the right to sell the same
100 shares at a price of 55, expiring in 1 month. This would cost you $550 (quoted
as 5.50).
The 5.50 total value of the option is composed of two elements:
The 'intrinsic value', which is the amount the option is worth if it expired today
(in this case, your right to sell at 55 is worth 2.00 = right-to-sell price of 55
minus current stock price of 53).
The 'time premium', which is the remaining cost after subtracting the intrinsic
value. In this case, 5.50 - 2.00 = 3.50 points of time premium. The longer the term
of option you select before it will expire, the more costly the value of time will
be.
The call option we have selected, with the right to sell at 55, is known as an
'In-The-Money' option, because it has intrinsic value. I like to purchase
in-the-money options as a stock substitute, as this allows you to participate more
quickly point-for-point as the stock moves in your favor.
Looking at the payoff versus risk in the option strategy compared to buying the
stock, we see the following at the expiration of the option in 1 month:
BENEFIT IF: Stock closes under 55.00 at expiration.
BREAKEVEN IF: Stock closes at 49.50 at expiration.
LOSE IF: Stock closes above 55.00 at expiration. This position would be a 100% loss
if the stock closes over 55 at expiration.
Notice the leverage potential if the stock moves under 49.50 to your target at 44.
You would make 17% on your stock, but your option would gain 100%. This would give
you leverage of 6 times buying the stock outright. The breakeven for puts is
calculated by subtracting what you pay for the option, in this case 5.50, from the
strike price you purchased, in this case 55. The option would lose over 49.50 at
expiration, though realize something else. The option would save you money if the
stock surged over 58.50. Why? Because if you sold 100 shares of the stock at 53,
that would put $5300 at risk. Over 58.50 you lose more than $550, which is the cost
you spent to buy the option. You cannot lose more than the $550 (plus commission)
that you pay for the option. As a result, options can actually minimize your dollars
at risk in a volatile stock that happens to plunge badly. Futures traders can also
use this same method to cap their risk on a futures option as a replacement for the
future, while maintaining the opportunity to leverage their investment many times
over.
Strategy #2: Longer-Term 'LEAPS' Options
Let's look at another stock FGH with a longer-term perspective. You think FGH stock
should go from the current price at 60 to 40 or lower by the middle of January 2005.
This gives you over 18 months to be proven right in this example. If you shorted the
stock, 100 shares would put $6,000 at risk. In contrast, you could buy 1 longer-term
option contract that gives you the right to sell the same 100 shares at a price of
70, expiring January 2005, at a price of 15.00 ($1500 per contract). Options
expiring more than 1 year from the current date are known as LEAPS options (which
stands for "Long-Term Equity AnticiPation Securities"). These longer-term options
can have expiration dates of up to 3 years before they expire, which allows you to
not worry about short-term fluctuations if you have a longer-term view.
In this case, the 15.00 options cost is divided into an intrinsic value of 10.00
(your right to sell at 70 could be converted (or 'exercised') to then buy at the
current price of 60 and pocket the 10 point difference) and the 'time premium' is
5.00 (15.00 total - 10.00 intrinsic).
Looking at the payoff versus risk in the LEAPS option strategy compared to buying the
stock, we see the following at the expiration of the option in January 2005:
BENEFIT IF: Stock closes under 55.00 at expiration.
BREAKEVEN IF: Stock closes at 55.00 at expiration.
LOSE IF: Stock closes over 55.00 at expiration. This position would be a 100% loss
if the stock closes over 70 at expiration.
The leverage potential if the stock makes your target at 40 by January 2005 is 2
times that of owning the stock, as you would make 50% on your stock, but your option
would gain 100%. The breakeven for puts is calculated by subtracting what you pay
for the option, in this case 15.00, from the strike price you purchased, in this case
70. The option would lose over 55.00, and over 70 your option would expire worthless
in January 2005. Over 75, the LEAPS option would cost you less dollars than selling
the stock outright.
So you can see how options strategies that help you participate in a stock's downside
for much lower total dollars at risk can allow you to enjoy leveraged gains if the
stock drops significantly, while also managing your risk. Some investors may want to
put the rest in cash to be safe, while more aggressive investors may want to
diversify some extra capital across other situations. In such cases, options can
give you more flexibility to create additional opportunities for your capital to
grow. And if your stock proves to be relatively volatile either up or down, options
will often prove to be a much more effective way to profit from the downside in a
stock, while reducing the amount you could lose if the stock happens to rise sharply.
Se não receio o erro é porque estou sempre pronto a corrigi-lo
There's no bull side and no bear side. JUST THE RIGHT SIDE!
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