Taipan Feature: The Art of Options
Reduce market volatility, hold stock, and protect your gains: playing “puts” for fun and profits

by Bryan Bottarelli

You want to know if the worst is over? If you can safely buy stock again?

My response: Who cares what the markets are doing? Mind you, I’m not completely indifferent to moving markets. Quite the contrary.

Investing is a game that revolves around taking what the market gives you and profiting from it. Profiting no matter what the markets are doing: that has been the Taipan Group’s motto since our inception back in 1988, as the members-only publication of the profit-seeking Passport Club…

If you subscribe to Options Underground, you’re familiar with my approach to protecting stock positions with downside option “puts.” And you’re also familiar with the gains your option puts have made you, like 63%, 177%, 125%, 34%, and 87%. Now, it’s time to start applying this winning strategy to our new Taipan recommendations.

Volatility = being long on stocks
As a hedge against these violent swings, I am going to be implementing a new twist in Taipan, one involving stock options. Now, don’t get scared off. Sure, options are esoteric. And sure… you can lose your shirt on uninhibited options gambles.

But, when used in a limited, controlled way, they can make you huge profits and protect your stock gains at the same time.

Whenever you open a new position in a stock, you can simultaneously buy an option “put” on that stock. One great place to find option price listings is on Yahoo Finance. Just enter your stock’s symbol and follow the links to the options listings.

Buying an option put will serve as your hedge against your stock going down. Think of the option put as an insurance policy.

Sure, a hedge will cut into your profit margin, but it will also cut down on your losses.

The basic idea of hedging is simple. Invest in something that moves in the opposite direction of your investments. When your hedge loses money, your investments make money. When your investments lose money, your hedge makes money.

The key to successful hedging is spending as little as possible on your hedge. A hedge should cover potential losses without eating away too much at profits. If your US$10,000 stock portfolio appreciates 10%, and your hedge costs US$1,000, you don’t make any money.

Options are the best way to leverage yourself and your stock portfolios. An option put is the right (but not the obligation) to sell 100 shares of stock at a specified price and a specified time. Puts (and all other options, for that matter) allow you to take positions in the underlying stock with a minimal amount of capital. Most times, it’s pennies on the dollar.

For example, say you buy US$10,000 worth of Amgen stock. Using this new hedging strategy, you will also buy an “at the money” put option. (You’re buying Amgen stock for US$60 a share, and simultaneously buying a put—which gives you the right to sell 100 shares of Amgen for US$60 a share.)

Currently, these options cost roughly US$5 per share, and they’ll give you the right to sell 100 shares of Amgen stock for US$60 a share (US$6,000 worth of stock) for US$500 (US$5 premium/share multiplied by 100 shares). You only have to put 8.4% down for the right to sell the stock for US$60.

This means if Amgen (which you just bought for US$10,000) ticks down to US$56 a share, you’d lose roughly US$800. But your option put, which appreciates as the stock goes down, would cover those losses. After a while, you’ll see that you can double or triple your money on a premium if the stock goes down only a few points.

With the NASDAQ continuing to sell off, I suggest contacting your broker and getting your accounts set up for options trading. I foresee a robust end-of-summer rally, and when it happens, we want to be ready to protect our gains.

For more information on options trading, log on to Taipan’s newest options trading service: www.indxtrader.com.