Archive for March, 2013

Option Mini Contracts Debut

In what I believe is very good news for investors, option mini-contracts made their debut (test) yesterday as a pilot program. The test is in 5 different securities……AAPL, GOOG, AMZN, SPY, and GLD. Where I can understand AAPL, GOOG, and AMZN due to their price, I am not sure why they included SPY and GLD. However, I can easily see why the three stocks were included. They offer an opportunity for the individual investor that was not previously there.

For whatever reason, today companies seem to be enamored with high dollar stock prices.  In the past, once stock prices got into the triple digits, companies split their stock in order to keep the dollar prices reasonable enough to keep the individual investor interested and able to buy. Recently however, triple digit stock prices have become “sexy”- a way for companies to show they are “hot” (successful). The problem is that the total dollar price of these high flyers all but eliminates the ability for an individual investor to play.

Even option traders have problems with the total cost of these expensive stocks. The Stock Replacement Strategy can be very cost efficient and can help investors neutralize the expensiveness. However, even this strategy can be cost prohibitive when prices soar way beyond the norm. For instance, if today, I wanted to buy a stock replacement option six months out in GOOG that option would cost $120.00. Calculate $120.00 x 100 shares and that means $12,000 for one contract. That is just too much money for one contract for the average investor!

As option traders, we  do have a strategy that can offset some of that expense, give us a limited downside risk and a decent percentage return. That strategy is the Vertical Spread. The problem is that the vertical spread also gives us a very limited profit potential! That is definitely NOT what we want in stocks like AAPL, GOOG, and AMZN! These stocks can have huge runs and we don’t want to make $3.00 on a $60 or more movement!

The mini-contract allows the investor to create the right strategy at the right price. Now, with the mini-contract available, we can buy one contract worth 10 shares for $1,200 a contract. This allows an investor to get into a position at a tenth of the cost! The Stock Replacement Strategy becomes affordable for almost everyone and now these sexy stocks can be once again played by individual investors!

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The Ultimate Put

The best way to protect your long position is to buy puts against it. This can be done on an individual position or an entire portfolio. But, if I have learned anything in this market environment it is that my thought that options are the ultimate hedge was never correct. The real ultimate hedge, as it is today, is the US Federal Reserve Bank…..The Fed!

Ever since the Financial Crisis, the Fed has been bailing people out, pumping money into the economy and now buying every piece of US Government Debt that they can get their hands on.  They need to buy to keep interest rates at near zero and have promised to do so through 2014 and possibly longer. This tactic has the effect of a put on the market that allows for huge downside protection like a real put would. All dips are suddenly buying opportunities because there is nowhere else to put your money.

But, it is more than that just that. With the Fed buying so much of this debt at ridiculously low levels for an obscenely long period of time, the Fed is creating an opportunity for bond traders. This is what makes this the ultimate put. You see, the long term buying of the debt at such low rates gives traders the chance to short the debt securities with the very high probability that the bonds and bills will decrease in value as rates go up and that is very likely down the road.

Shorting these securities puts money in their accounts……..money they need to put to work. And with rates so low, the money managers have only the stock market to put the money into to create any kind of acceptable returns. With all of this additional money going into the market, it would be very difficult for it to go down.

Wow, that is one hell of a put! It is the Ultimate put! It is the Fed that is the Ultimate Put!