Never lose more than 10%, ever!

B

billb2112

The big bosses were in a meeting yesterday. Come to find out, they met with a company about switching the 401K over. Boss said that the very nice thing was is that they'll never lose more than 10%. I said "How's that?" ... he said "puts". Really? Who buys the puts and when? What happens when the market bounces and the puts are worthless?

Boss: Uhhh ... you're beyond me, but these people had it together, they know what they're doing.

Is this yet another little scam by these money managers? Maybe they're buying out of the money puts that have long expiration dates? Maybe they're constantly hedging w/ puts? I just don't see how you can hedge for free and never lose more than 10%. If so, wouldn't everyone do it? Perhaps they've limited the upside, but never talked about that.

This is why I don't put a dime into a 401K.
 
heh ... damn good idea. In fact, I proposed what you just said and finally got a little more truth. They're limiting their upside, so perhaps they have a straddle or spread.

So now that they've all lost their asses the past 3 years, they're going to start limiting their upside when the market rebounds. Classic.
 
yep. when the geniuses that run the 401k's are buying puts, well, we should expect a rally like the one we're in the middle of, shouldn't we?
 
I wonder if it's possible for me to find out when they're about buy puts w/ the employees money so I can sell them the puts. heh.
 
The strategy is simple:

Buy stock at $40
Buy the $35 puts for about $1.90 - 2.25 (I'm just pulling the numbers from my head, but real prices shouldn't be too far from that.)

If stock goes down, there is no way you can lose more than $5. You have put in a floor at $35. If it goes up, then your puts expire worthless.

I feel the best way to use this strategy is to "re-hedge" once the market goes up. At the point when you can sell your 35 put and buy the 40 for a net of $1.00, then do it (stock will be about $48 or $49. Keep doing that as it climbs.

At some point in the year there is going to be a big drop in the stock, and that is Payday. (example: stock is up to $60, you own the 50 puts, and it drops to $40. Sell those 50 pts for $10 each, buy more stock, and start the process over.)

Above is a huge oversimplification, but that's the basic idea behind the strategy. My numbers don't reflect their 10% guarantee, but that is the general idea. Basically you are paying a "premium" to insure your stock, but not limiting the upside.

Personally, I would not own stock any other way. There will ALWAYS be a fire on Wall Street two or three times per year, and it's good to have insurance when there is. The hard part is paying the premiums every month when nothing seems to be happening.

Hope this helps to clarify...

kp
 
To me that is a huge oversimplification. When you sell your puts, what happens when the stock goes from $40 to $35, you sell your puts and the stock goes to $25. Do you buy more or count on a bounce? What happens when there is a 5% run up in the market over three months and you paid 5-10% in insurance and all of it expires worthless? Yes, you have gain on the stock, but with the puts you break even or make a little. And if the experts are right (cough!), it's going to be a "trader's market" for the next several years so there will be a minimal gain, say 1-2% and you paid 2-3% for "insurance", so you've lost money.

I guess I can see the 10% loss guarantee, but I think there's going to be bigger hampering of gains than people were lead to believe yesterday.

You obviously understand what you're doing, but I think for folks who just learned what a put was yesterday they're going to get taken.
 
To me that is a huge oversimplification. When you sell your puts, what happens when the stock goes from $40 to $35, you sell your puts and the stock goes to $25. Do you buy more or count on a bounce?

According to the strategy, you ALWAYS re-hedge. If you have a big 'correction' and are holding puts in-the-money, and your tea leaves say this is the bottom, then you sell them, buy more stock, and BUY MORE PUTS to insure all your current stock. (1000 shares, Stock drops from $50 to 25, you have 45 put, so you sell 45 puts for $20 ($20,000) and buy about 800 more shares of stock. Then you buy 15 strike puts to cover your positioni of 1,800 shares.

If you don't know when the bottom is going to be, you can always wait for expiration. If your puts are in-the-money at expiration (sock has gone down) sell them, buy more stock and re-hedge. If they expire worthless, stock has gone up or stayed flat, buy more for the next month.

What happens when there is a 5% run up in the market over three months and you paid 5-10% in insurance and all of it expires worthless? Yes, you have gain on the stock, but with the puts you break even or make a little. And if the experts are right (cough!), it's going to be a "trader's market" for the next several years so there will be a minimal gain, say 1-2% and you paid 2-3% for "insurance", so you've lost money.

You are very correct. This strategy LIVES on volatility. If you only get a 5% move in three months, you are losing money. Over the long-run however, you have a pretty good chance to make money.

I guess I can see the 10% loss guarantee, but I think there's going to be bigger hampering of gains than people were lead to believe yesterday.

You obviously understand what you're doing, but I think for folks who just learned what a put was yesterday they're going to get taken.

That is the point. Most people own stock long-term and have no concept of hedging. In the '90s this was no problem because everything was going up. I venture that ANYONE using this kind of strategy over the past three years would much farther ahead of all the "buy and hold" people. Maybe they aren't up 20% or whatever, but they still would have most of their money.

My main point is this is not a scam, but a valid method for managing stock positions for the long-term. The tradeoff is that you are paying pemium, but it gives you protection and you will not see your portfolio wiped out by a 50% decline in the market. You will also not benefit from small moves to the upside.

Cheer,

kp
 
BTW,

Last week I started a thread in the Options forum to demonstrate this type of strategy. The title is "Hedge 'n Hold."

I am using one stock, ELX and will use this type of method for the coming year. ELX has moved up from my price almost a dollar. If it goes up a bit more, I'm going to re-hedge, and lock in the profit. We'll see what happens.

Peace,

kp
 
Thanks for the clarification and real world examples. I hear my co-workers and friends whine quite a bit about their losses and I genuinely feel for them. I'd hate to see them get cut again especially by some snake oil salesmen. Maybe this is quite viable given the current conditions.
 
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