What You Need to Preserve Your Profits
With stock markets having set multiyear highs just over a week ago, some anxious investors want to pursue ways to help them lock in their gains from the past three years. For many, certain strategies using options would potentially let them protect their gains while still giving them some upside exposure.
Unfortunately, many stocks traditionally haven't worked well with options strategies unless you have tens of thousands of dollars invested in them. A recently announced plan to create some innovative new options products could open the door to mainstream investors being able to use these strategies much more effectively.
Later in the article, I'll talk about this new innovation. But first, let's take a quick look at the general options strategies currently available and why they don't always work as well as they should.
Buying crash insurance
Many people associate options with highly risky strategies that resemble playing the lottery. Certainly, some options strategies give you the chance to use leverage to turn small investments into huge windfalls -- but usually with a much larger chance of losing every penny you invest.
By contrast, some protective options strategies let you reduce the total risk of your portfolio. If you buy a put option on shares you already own, for instance, you'll have the right to sell your shares at the option's specified strike price anytime between now and when the option expires. If the share price falls below that strike price, then you can exercise your option and effectively avoid any further loss. And if the stock goes up, then you simply let the option expire, losing what you paid for the option but pocketing the extra gain from your shares.
The problem, though, is that each options contract covers a 100-share position. That works fine when you own some multiple of 100 shares in your account -- you simply buy one put option for every 100 shares you own. But for Apple (NAS: AAPL) , priceline.com (NAS: PCLN) , and Google (NAS: GOOG) -- some of the more successful stocks of the past decade -- share prices of $500 apiece and above mean that in order for a 100-share options contract to fit perfectly with your stock position, you have to have upward of $50,000 invested in a single stock. And given the massive gains on those high-priced stocks as the mobile revolution has taken hold and Priceline has asserted its dominance over the online travel-portal space, many investors are most interested in getting protection on them.
To address that problem, options exchanges -- including NYSE Euronext's (NYS: NYX) , NYSE Arca Options, and the International Securities Exchange -- plan to talk with the Securities and Exchange Commission to consider "mini-options" that would cover 10 shares instead of 100. With so much trading in those high-priced stocks taking place using odd lots of less than 100 shares, having options contracts that match up with investor needs could greatly increase option demand.
The move could even have an impact beyond traditional stocks. As a Bloomberg report on the proposal pointed out, the SPDR Gold Shares (NYS: GLD) trades at prices where one share is roughly equivalent to a tenth of an ounce of gold. With a 100-share round lot representing 10 ounces of gold, mini-options would reduce that commitment to the equivalent of a single ounce -- a much more manageable amount for many ordinary investors looking to diversify their portfolios with gold exposure.
Preliminary drafts of the proposal would have mini-options available only for stocks with minimum prices of around $100 to $150 per share. Obviously, the high-profile nature of Apple, Google, and Priceline make them ideal candidates from the exchanges' standpoint, as they're only interested in products that investors will actually use.
Even if they eventually come in smaller packages, buying put options can still be expensive. But as a way to avoid losses from short-term moves, put options can be useful in certain situations. As they become more readily available to investors, you should consider taking a closer look at whether put options could be helpful in your portfolio.
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At the time this article was published Fool contributor Dan Caplinger likes keeping his options open. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Priceline, Apple, and Google. Motley Fool newsletter services have recommended buying shares of Apple, NYSE Euronext, Priceline, and Google, as well as creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is a great option for you.