Put PUTs To Work As Insurance Against Disintermediation

Posted By Barry Brush |  Subscribe in a reader | Comment 1

clip_image001 2DIME’S INVESTOR NOTES By: Barry Brush

April fool’s? With massive withdrawals and disintermediation* facing us to pay upcoming tax bills on April 15th, one would be ill advised to buy into this market. That is unless you are selling short. I’ve been standing on my head all week trying to make sense out of what’s up with this market. I found the answer while doing a handstand at my computer and typing with my toes. While looking under my desk, I was able to confirm that we are in a down trending market and as Alice would say, up is down.

What will the Government do with all those tax receipts anyway? Grind them up and re-issue them in Junk Auction-Rate Securities with dividends that are tax credits? Hmmm? No earnings – no taxes – no tax credits – no buyers for Junk Auction-Rate Securities or SIV’s – no earnings? – Hmmmm?

Don’t forget to file your tax return this year so you can get your rebate. Don’t make enough money to file? Hmmm? How much is $168 Billion? Hmmmm?

If you don’t want to shoulder the financial risk and burden of inactive capital while selling short, my advice is to discover PUTs… Buying a PUT on a stock you own is like buying insurance against a decrease in its value. Like Insurance, every month or so, the premium must be paid because the policy will expire if you don’t. Cool thing is that with a PUT you can, in effect, insure anyone’s stock, house or life without owning it or living it and be paid a benefit check if it declines in value or dies.

If you aren’t comfortable with PUTs, remember they are like calls with an opposite expectation of price movement. Look for a strike price with 6 – 8 weeks until expiration and a DELTA of .70 or more. Buy a lower delta strike for longer term options because the delta will increase over time as well. Don’t knock yourself out over implied or historical volatility, their relationship or option price charts showing risk and potential profit zones. All are nice to know; but I think it best to keep it simple. Just like a stock, option selection is all about price, volume, liquidity, momentum and the earnings potential of the company.

There is an optimal risk/reward point between one contract with a high delta and multiple contracts with a lower delta for the same amount of risk/$. Sometimes your ROI can actually increase if you spread the same dollars over more contracts. Just like a call, open interest should be no less than 100 contracts. Theoretical value should be approximately equal to the ask & preferably more. The Bid/Ask spread needs to be reasonably narrow (I’d say not more than a point or two) and ideally divisible by thirds. You want to be able to get in and out whenever.

As far as the current downtrend is concerned, take advantage of it. You don’t have to be wall flowers like the institutions are right now. Try to over come the paradigm of buy low sell high and waiting for a dividend; and acknowledge that traders can and do make money in any market. If you still aren’t sure about PUTs, check out the following ETFs: QID, DXD, SDS, the TWM or the DOG; you can even buy them outright like plain old atavistic shares of stock or you could place a couple of CALLs. J

Yesterday I paid $66.00 at Wal-Mart to fill up the 20 Gal. tank on the wife’s SUV. They even put a little corn syrup in the mix. Driving away from the pumps I noticed that there were no lines to buy more. It gave both me and the car bad vibes. The fill up was a 40% increase from this time last year. It’s the same increase as the price of corn and food over the same period. Hmmmm…? And I hear diesel fuel is going for more than a buck now. ($4.25/gal) Somehow, I don’t think the Trannies are going to let this Bear Market off the hook. (Jets, Trains, Trucks and Tractors all use diesel).

That being said, have you checked out the railroads lately. In my opinion, the value of a train ticket is underpriced and has some room to grow. Check out BNI and CSX. My son recently found that a round trip train ticket from Charleston, SC to Greensboro, NC was only $112 while the cost of gasoline alone to make the drive would run him $120 for the two tank fix his Beemer would need. Go figure. $8.00 is still a savings of 7% which is not a bad rate of return over a two day period. I hear it’s even safe to “text” on the train; and I think he can take his pocket knife with him for the ride.

All this, and the gremlins that keep blowing up pipelines and monasteries will make for an interesting school year; but, go ahead and start studying for the final exam. It’s probably multiple choice and every question will have more than one OPTION for the correct answer.

*Note: Disintermediation
The withdrawal of money from low yielding financial accounts, such as saving accounts, and the reinvestment into higher yielding securities such as Treasury bills. Banks, in an effort to keep the money, may pay depositors higher rates. In order to afford the higher rate, banks will then charge their borrowers higher interest rates. This can possibly lead to tight money and reduced economic activity.

Cheers, 2dimes ;-)     

P.S. Your comments are always welcome

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