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Lane, JD, CFP, MBA
Lane, JD, CFP, MBA, JD, CFP, MBA, CRPS
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Hedge advice, I have a stock that got hammered and I believe

Customer Question

Hedge advice, I have a stock that got hammered and I believe it will rise again so I really don't want to sell and miss out on a rise in price. I need to free up funds and have to sell some. I don't want to sell because it's so low, I would so much love to be a buyer of this stock if I had the funds. Anyway, how is the best way to sell some of the stock to free up funds but also sell some extra to buy an option, future, margin, leverage etc. or whatever would be best that would exponentially rise in value if the stock goes up so that if it rises enough, it will cover at least if not more than what I missed out on from the stock I sold. I know there are a lot of strategies, and many factors but please give a laymens terms example, advice/explanation. Maybe use this for the example?
Have $5,000 in Walmart stock, I need to sell $2,000 worth, stock price is $20, I believe in the next 6 months but definately in 2 years, it will get to atleast $25 but probably $35 or more. If I were to sell $500 extra of the Walmart stock, what's a good suggestion of how to divy it up into different options etc. for Walmart stock that will achieve my purpose if the stock rises. On a side note, I know it's all a crapshoot, and I wouldn't hold you too it.
Submitted: 1 year ago.
Category: Finance
Expert:  Lane, JD, CFP, MBA replied 1 year ago.

NPVAdvisor :

Hi Leverage can be accomplished here in several ways. 1st lets talk about leverage ... Leverage magnifies gains ... AND ... magnifies losses.... All leverage really means is investing in something without putting your own money into it .... The most common example is borrowing from someone else to invest ... If you have a brokerage account you can do that with margin.... (a Margin account is simply a brokerage account that lets you borrow money to invest with) .....

NPVAdvisor :

The math is simple ... If I invest $100 and make $10 - I just made 10% ... I I borrow $90 and invest $10 of my own money and and make $10 - I just made 100% (I invest $10 of my own money and made $10 ... that 100% return on MY money) ... Now, I do have to pay back the $90 over time ... but I have really leveraged ... My return drops a little because I have to pay that back over time BUT it's still MUCH higher by using OPM (Other People's money)... That's the effect of leverage, (on the PLUS side)

NPVAdvisor :

What if the investment LOSES money NOW not only have I lost my own money..., but I still have to pay back the loan .... SO ... My LOSS is magnified, Just as the Gain was maximized

NPVAdvisor :

What are the ways to do that?

NPVAdvisor :

(1) Margin lending in a brokerage account (Just remember that if the investment you make loses money ... at some point .... you will get what's called a margin call - typically when your investments can't even hold 50% of the true value

NPVAdvisor :

(2) Borrow the money from someone else .. a bank, etc. ... at least this way, you won't have to come up with a certain amount of money just because the investment has lost a certain amount ... and for long term investments, tat do eventually come back, that may be OK

NPVAdvisor :

(3) Another way is options ... an option is a contract to buy or sell at a certain price. Walmart is an about 78 right now .... If you think WMT is going up ... you might but an option to buy (a call) at 85 ... by a certain date ... and lets say that Wal Mart goes up to 100 ... you can exercise your call option for a small amount of money, immediately buy Walmart at 85, and turn around and sell immediately at 100. (What do you have to lose? .... only the cost of the options contract) Remember the cost of an option (a right to buy or sell at a future price) is only a small percentage of the price to actually buy or sell the stock ... so again LEVERAGE

NPVAdvisor :

There are several benefits to buying stock options as opposed to buying the stock outright. They are relatively inexpensive, particularly when compared to the cost of the underlying instrument. For instance, you might be able to buy stock in XYX Corp. for $1000 per share. Stock is commonly traded in blocks of 100, so you would spend $10,000 for this position.


You can control the same amount of stock for a fraction of that price by buying an option instead. The options might be listed for 8 points. So by purchasing options, you will spend $800 instead of $10,000 to control 100 shares. (Stock options are for 100 shares, so $8 X 100 shares gives you the price of $800, not including your commission.)

NPVAdvisor :

So options, are a way to use leverage without the risk of actually buying those shares with someone else's money.... If things don't go the way you think they will ...you don't actually pay back the money, you just lose the small cost of the option (the contract that would have let you sell above the market price or buy below it)

NPVAdvisor :

I would recommend options, rather than margin or other borrowing. ... less risk with ALMOST as much leverage

NPVAdvisor :

Hope this helps

NPVAdvisor :

Lane

Lane, JD, CFP, MBA, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 4379
Experience: Providing Financial, Tax & Business advice since 1986
Lane, JD, CFP, MBA and other Finance Specialists are ready to help you
Expert:  Lane, JD, CFP, MBA replied 1 year ago.
Our chat has ended, but you can still continue to ask me questions here until you are satisfied with your answer. Come back to this page to view our conversation and any other new information.

What happens now?

If you haven’t already done so, please rate your answer above. Or, you can reply to me using the box below.
Customer: replied 1 year ago.
Thanks I just accepted, mainly, I was already planning to go the option route. When I have done it years ago, I saw that I could only go as far as 12-18 months out for the length of the contract, or something like that....
1) How far out can I go
2) is the price of the contracts the same no matter who you buy it with?
3) do I need to shop around for options or doesn't matter?
Expert:  Lane, JD, CFP, MBA replied 1 year ago.

On the terms of the contract it's a market driven issue.... you can by a call as far out as someone out there is willing to sell one.

Yes the contact prices and the market makers are typically pooled at/by the the CBOE (Chicago board of options).

No, if you go with a good platform like Interactive Brokers(or one of the best ones out there for beginners AND experienced traders alike ... Options Express, the prices are standardized.

Check these guys out... Lots of support, education and education:

http://www.optionsxpress.com/free_education/education_center.aspx


Lane
Lane, JD, CFP, MBA, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 4379
Experience: Providing Financial, Tax & Business advice since 1986
Lane, JD, CFP, MBA and other Finance Specialists are ready to help you
Customer: replied 1 year ago.
Is it safer to buy an option that has a large volume? Looks like some have little volume, would I have more of a chance of "getting a bad value"because there isn't enough volume to balance out it's fair value?
Any good advice for a beginner with options, common mistakes etc?
Expert:  Lane, JD, CFP, MBA replied 1 year ago.

Hi Tim, yes large volume is ONE is one indicator, (look to see the direction) .i just stepped into a 3:00 meeting. If you would, check back in, in a cous of hours and I'll list sOK other things.

Hope that's OK

Lane
Customer: replied 1 year ago.
Okay I'll wait, just please give me all you can to help and I'll direct more questions in the future
Expert:  Lane, JD, CFP, MBA replied 1 year ago.
Thx will do
Expert:  Lane, JD, CFP, MBA replied 1 year ago.


Tim, question ... did you use the site I gave you before, to do practice runs?

The reason all the big options platforms have these is because trading options (like math) is a participation sport.

Only experience will really help you to understand all of the ins, outs and ways that you can get absolutely get KILLED trading options (especially if you lose track of a contract).




Here are the big things to watch out for:


Not having a way to get out, and get out quickly, if you need to:

Options are what's called Options are a decaying asset. And that rate of decay accelerates as you get closer to your your expiration date.

So if you’re in a long position (put OR call) and the move you predicted doesn’t happen by the time you thought it would, get out.

HOWEVER, When you sell options without owning them, you’re putting time decay to work for you (If, for example, if time decay erodes the option’s price, and you get to keep the premium received for the sale)

Essentially, don't wait around on profitable trades because you're greedy, or stay way too long in losers because you’re hoping the trade will move back in your favor.



Illiquid options:

“Liquidity” in the market means there are active buyers and sellers at all times, with heavy competition to fill transactions. This activity drives the bid and ask prices of stocks and options closer together.

As your strike price gets further away from the at-the-money strike and / or the expiration date gets further into the future, options will usually be less and less liquid. SO, of course, the spread between the bid and ask prices will usually be wider.A stock that trades fewer than 1,000,000 shares a day is usually considered illiquid. So options traded on that stock will most likely be illiquid too.

Remember, the greater the volume on an option contract, the closer the bid-ask spread is likely to be. Remember to do the math and make sure the width of the spread isn’t eating up too much of your initial investment. Over the long-haul the numbers can really add up.





If your short option gets way out-of-the-money and you can buy it back to take the risk off the table with a profit, do it.




You might be tempted to buy the long call first and then try to time the sale of the short call with an uptick in the stock price to squeeze another nickel or two out of the second leg. BUT MANY TIMES the market will downtick instead, and you won’t be able to pull off your spread at all. Now you’re stuck with a long call with no way to hedge your risk.




These are a few of the typical beginner mistakes.

BY FAR, the best advice I can give is get that account, practice practice practice ... and when you've been profitable with any predictability at all.... get your feet wet with some money.

And don't start with multiple trades ... even the BEST options traders have lost their shirt that way.




Now, in terms of valuing a contract? (This is from an excellent article on options monster): http://www.optionmonster.com/education/options_basics.php


Option Price and Value

Premium

In exchange for the right to buy ("call") or sell ("put") an underlying security on or before the expiration date, the purchaser of an option pays a premium. The price of the contract is known as the debit, and it is the purchaser's maximum risk. On the other side of the trade, the seller of the option receives the premium as a credit to his/her brokerage account, but is obligated to buy (in the case of a short put) or sell (in the instance of a short call) the underlying shares if the purchaser exercises the contract. Brokerages hold cash from the premium as a guarantee against short positions.

The strike price, or exercise price, of an option determines whether that contract is in the money, at the money, or out of the money. If the strike price of a call option is less than the current market price of the underlying security, the call is said to be in the money because the holder of the call has the right to buy the stock at a price which is less than the price he would have to pay to buy the stock in the market. Likewise, if a put option has a strike price that is greater than the current market price of the underlying security, it is also said to be in the money because the holder of this put has the right to sell the stock at a price which is greater than the price he would receive in the market. The converse of in the money is, not surprisingly, out of the money. If the strike price equals the current market price, the option is said to be at the money.

CallPut
In the money (ITM)Strike price < Stock priceStrike price > Stock price
At the money (ATM)Strike price = Stock priceStrike price = Stock price
Out of the money (OTM)Strike price > Stock priceStrike price < Stock price

Intrinsic Value and Time Value

The premium of an option has two components, intrinsic value and time value.

Intrinsic value describes the amount the stock price is above the strike price (for calls), or below the strike price (for puts). Therefore the amount by which an option is in the money is intrinsic value. It is also the value of the contract at expiration.

Time value is defined as the option premium minus the intrinsic value. It is the amount that you pay for the possibility that it will be worth more in the future. Therefore an at-the money or out-of-the-money option has no intrinsic value and only time value.

CallsPuts
Intrinsic Value = Stock Price - Strike PriceIntrinsic Value = Strike Price - Stock Price
Time Value = Option Price - Intrinsic ValueTime Value = Option Price - Intrinsic Value

Intrinsic value is only affected by moves in the underlying security.

Time value is subject to several factors, primarily time to expiration and implied volatility. Implied volatility is the market's expectation of the future volatility of the underlying stock. It is derived from the option price itself, and represents demand for the option. The higher the implied volatility, the more expectation that the underlying stock will make big moves, increasing the option's chances of being in the money. This also means that the option's premiums (that is, its time value) are higher. However, the value of time decays as expiration nears: time decay increases dramatically in the last 30 days as expiration approaches.

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Let's consider an example using Google (GOOG). If GOOG were trading at $500 when you bought a 490 strike call option for $25, then $10 of the option's value would be intrinsic value.

The other $15 would be time value. A 500 call purchased when GOOG is trading for 500 is at the money, but is all time value. It has no intrinsic value.

If the stock were at 500 when you bought a 510 call, the option is again all time value, since it has to rise $10 to be in the money.

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