Insurance

[stargazer]

Hi all

When you buy shares just like a car or house it is advisable to insure these items to minimise the risk.

In the case of shares from what i understand there is a few ways of doing this.

1. Stop Loss.
This is setting your price where you accept the loss if trade goes against you.
Qu. If you have a stock at say $5 and stop loss at say $4.50 and the price gaps down to $3.80 WHAT HAPPENS?

2.Put Option
This is where you buy the Put of a period with a srike price that you will sell the stock at a particular price. EG. Buy put option to sell the stock at $4.00 price drops to $2.00 you sell the stock at $4.00.

Not sure if all this is correct but is there better ways to handle the risk or are these probably the best ways. Have to take into consideration the cost etc using options etc.

If you see a stock you feel is going to go up but want to protect the downside.
Buy the share first or buy the put first then the share?
Buy the share and place stop loss?
Buy the share buy a put option sell a call option?

Cheers
SG

 

[mazzatelli1000]

Hi all

When you buy shares just like a car or house it is advisable to insure these items to minimise the risk.

In the case of shares from what i understand there is a few ways of doing this.

1. Stop Loss.
This is setting your price where you accept the loss if trade goes against you.
Qu. If you have a stock at say $5 and stop loss at say $4.50 and the price gaps down to $3.80 WHAT HAPPENS?

2.Put Option
This is where you buy the Put of a period with a srike price that you will sell the stock at a particular price. EG. Buy put option to sell the stock at $4.00 price drops to $2.00 you sell the stock at $4.00.

Not sure if all this is correct but is there better ways to handle the risk or are these probably the best ways. Have to take into consideration the cost etc using options etc.

If you see a stock you feel is going to go up but want to protect the downside.
Buy the share first or buy the put first then the share?
Buy the share and place stop loss?
Buy the share buy a put option sell a call option?

Cheers
SG

Stop Loss - like what you say - if it gaps then what? Then you lose, stop losses aren't guaranteed

Put options are the "insurance" I guess, as you have described it above.

You buy the share and put option whenever market bias is favourable. No set rules that you must buy shares or put option first. E.g. share price falls, jump in and buy, buy the put when underlying is heading up

"Buy the share, buy a put option, sell a call option" - that is a synthetic bull spread - you can achieve that using options alone.

Also by selling the call option you will cap your maximum gain.

Alot of considerations - it is probably best to define exactly what you require.

 

[stargazer]

Hi mazzatelli1000

Thanks for your reply.

The example that i gave re: STOP LOSS is that would those shares be sold on you if it gapped below your stop loss price as per the example.

I am looking to figure out the better option for some protection.

Ror Example

Buy the Share at say $10.00 company XYZ
I think the share is a good buy and it should go up in medium to longer term.
At this stage i am exposed and my risk is the whole $10.00.

So buying a PUT option for say 12 months with a right to sell just in case the stock or market tanks and you get it wrong.

Nothing fancy but i am not sure at this stage which is the better way to go stop loss or using option. Can't think of any other way...

Cheers
SG

 

[mazzatelli1000]

Hi mazzatelli1000

Thanks for your reply.

The example that i gave re: STOP LOSS is that would those shares be sold on you if it gapped below your stop loss price as per the example.

I am looking to figure out the better option for some protection.

Ror Example

Buy the Share at say $10.00 company XYZ
I think the share is a good buy and it should go up in medium to longer term.
At this stage i am exposed and my risk is the whole $10.00.

So buying a PUT option for say 12 months with a right to sell just in case the stock or market tanks and you get it wrong.

Nothing fancy but i am not sure at this stage which is the better way to go stop loss or using option. Can't think of any other way...

Cheers
SG

I forgot to add that, in my previous post I suggested legging into the trade, but there is risk that the market may run away from you. An alternative is to buy the stock and put as one transaction - so you may need to find a broker that enables the entry of combination orders.

The stop loss - for example if you set it at $5, if the stock falls and it hits the $5 then you will be exited around this mark (assuming stop loss limit order). But if you leave it at market order or if the stock gaps down you could be selling it for much less - meaning a larger loss.

The put option will give you more control over the amount you will be selling your shares at. If you buy a $5 put option, no matter if the stock gaps to $2, you will still be able to sell it for $5, whereas with the stop loss you MAY have to transact around $2. However this is assuming this is at expiry, as there may be too much time value if you exercise your put option early.

Instead sometimes if the stock tanks, the value of your bought put will increase (intrinsic value and possibly an increase in implied volatility) and you will be better off selling the put option instead of exercising it to mitigate your losses.

As a last - a long put + long stock = synthetic long call - i.e. this position you suggested is the same as buying a long call. You may want to consider this as it will cost less than purchasing stock and puts, but there are other considerations like volatility and dividends etc.

This should give you some ideas to delve in more deeply as this bourbon is giving me headaches at the moment