Insurance Anyone?

Insurance?

Why would you NOT insure a STOCK PORTFOLIO?

I find it amazing when I discover how many people out there never even consider INSURING a STOCK PORTFOLIO. Even those who are aware that this can be accomplished through the use of OPTION PRODUCTS, they choose not to.

In a prior article I spoke about EXPOSURE to RISK and compared the huge differences between different strategies when a BULLISH OPINION was in play. The point here is to cover a situation when STOCK is in a portfolio and the investor plans on holding on to it long term.

Because of certain laws or plain discipline, we have always dealt with the need for INSURANCE. We insure anything from a cell phone on up to our homes and automobiles along with our health and several other possessions. The items we find a need to insure certainly vary in value, some are petty and some are quite valuable. Some people even find a need to insure a $5 hand in blackjack against a dealers exposed ace.

It would be alarming to know just how many people out their own shares of STOCK in a company and have never considered insuring against a steep decline in its value. Those same people will buy extended warranties on a computer or insurance to cover a lost $100 cell phone. Wouldn’t it make sense to insure a STOCK PORTFOLIO? We insure a $25,000 car why wouldn’t we insure a STOCK PORTFOLIO worth $25,000 or a portfolio worth even more?

A few months ago, I met someone who knew worked for Lucent back in the 90s. He told me he accumulated 10,000 shares of LU and was very much looking forward to a well-deserved retirement in 2 years. At the time LU was trading in the $60 area and his 10,000 shares were worth about $600,000. When I mentioned that it would be a good idea to protect his portfolio by purchasing some PROTECTIVE PUT OPTIONS, he seemed to think LU was invincible to any sharp decline. He said there was no need to waste any money buying PUTS because if anything he figured LU would be much higher when he retired in two years.

If you look at a historic chart on LU, you will see that when he retired in December 2001 his LU stock that was once worth $600,000 had dwindled to a value of around $55,000.

The stock price in that 2-year period went from the $60 area down to about $5. Even though his cost basis was nowhere near $60, the value of the portfolio is what should have been insured. If you bought a house for, say $100,000 and 20 years later it increased in value to a million, you certainly would NOT insure it for less than its value. The same idea should apply to a STOCK PORTFOLIO - At the time he could have INSURED the 10,000 shares of LU by purchasing 100 PUT CONTRACTS which was equivalent to 10,000 shares of stock. He could have bought at the STRIKE PRICE of 60,55 or even 50. He could have even spent a little more and did a ratio consisting of more PUTS than STOCK and made a profit on the declining LU. But to have an UNINSURED $600,000 PORTFOILIO, whether it be diversified with multiple companies or just one, it doesn’t

make sense to subject yourself to that kind of RISK EXPOSURE.

Cost of Stock Insurance

The lesson here is that no matter how small or large the portfolio might be, pay the small price to escape being vulnerable to a huge decline. It's quite simple and you owe it to yourself to PROTECT your portfolio. Chances are the STOCK or STOCKS you already own have OPTIONS available. Take a look at the STRIKE PRICES and the MONTHS ahead. You can select the term and level of coverage to fit your investment objective.

For an example, I will use IBM. If you owned 1000 shares of IBM, the value of the portfolio is $75,000. You can buy PROTECTIVE PUTS to protect the value of those 1000 shares of IBM for any decline under $70 for 2 weeks for a mere $50 or if you want to own IBM until January you can spend $1450 and be protected for any decline under $70 until the January 2007 EXPIRATION. A small price to pay for keeping your IBM PORTFOLIO VALUE at $70,000 and if a train wreck comes and IBM went to $20, you would be happy you had the sense to buy a PROTECTIVE PUT.

Happy Trading