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stevesequities (29.47)

February 2013



Reducing Risk Through Options

February 12, 2013 – Comments (6) | RELATED TICKERS: AAPL , WFC , XLF

 I just watched the preview video for the new MF Pro, and it made me nervous. I'm a reletively new options investor. Most of my options trades involve selling covered calls for income, exiting a trade by surrendering over shares at a strike price higher than my cost basis per share, or, if it's Apple (APPL), pure speculation. Because options can potentially cost an investor 100% of their premium paid, or the surrendering of their shares, I try to approach them with a sure footing and extreme caution. With that perspective in mind, I was instantly nervous when the MF Pro team mentioned hedging an investment in Wells Fargo by buying a JAN 2014 put and selling a JAN 2014 call in the XLF. I have heard of buying a put in the bank that I own (in the video's case WFC) in the event that there is a short term correction in the stock price. But the video's plan involved writing a naked call to reduce risk. A naked call. And, they mention that if the XLF rises by 10-20% (the max they say), the amount of downside there isn't too bad. OK, so if I sell 5 Jan 2014 calls and use the proceeds to buy 5 Jan 2014 Puts, what would I risk if the XLF price exceeds my call's strike price? Well, if I'm correct here, 500 shares of the XLF (5 contracts), which I would have to buy in the open market since I don't own any (naked calls). So I would have to go out and pay around $10,000-ish only to give it away to someone for a lower price, giving me a downside in the neighborhood of a couple thousand dollars. Also, my put is worthless (most likely) if the price went up by that level, so I wouldn't gain anything from that. For me, a standard position would be around $15k, and I don't think 10k of exposure from an option position to hedge that position would be out of line. For all the readers out there, please tell me if my logic on that options trade is out of line. Did I miss something there when they said that the risk is substantially reduced by BUYING the jan2014 put and SELLING the jan2014 call?   [more]

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