Over the past couple of years the falls in the value of superannuation and investment portfolios have been widely reported. Its been all doom and gloom with the press often reporting how many billions of dollars have been wiped off people’s investments.
We all know that investments are cyclical and that smart investors hold their nerve through the tough times. History shows that markets have bounced back even higher after every low. But how can we ease our minds during those tough times?
Many investors take advantage of insuring the value of their portfolio by buying put options on their stocks.
A put option gives you the right, but not the obligation, to sell your stock at a given level at any point in time up to the expiry of the option.
Let’s say, for example, that you own BHP shares and paid $8.80 for them. You are worried about the state of the market and, whilst you don’t want to sell your stock, you also don’t want to see it fall away sharply.
You can insure your stock’s value and give yourself absolute down side protection by buying a put option with a strike price of say $8.78 or possibly $8.54. That way you don’t care how much BHP falls away, you’ve got the option to sell them at those prices any time you like.
Of course, if BHP continues to rise you don’t need to exercise the option. You can say that it has cost you money to buy the put if the stock goes up, but it also costs you money to insure your house, and you don’t get angry if it doesn’t burn down, do you?
It is extremely important that before entering into any option contracts you read and become conversant with the ASX’s option booklets and terms and are comfortable that they are suitable for your style of investment.