Category: Finance.
Previously. We agreed that an important purpose for stability was having a more or less consistent ability to pay our bills, enabling our trading business to survive.
Earlier, we began a to investigate the need for stability in our trading business. Additionally, we outlined a strategy which had the ability to maintain our initial value( our emergency money) and the potential for making profits as well. A balanced straddle. The strategy. Amounted to finding a stock whose price oscillated above and below a particular value. As the price moved up and down, the value of our calls and puts moved up and down inversely, keeping the total value of the position roughly the same. If that value was also a strike price for that stock, then we could straddle it, buying puts and calls at that strike with several months before expiration.
In this way, our emergency fund was more or less kept intact. Stability Implies A Constant Value. In this discussion, we see how to draw a profit from such a position. If I have a minimum of six months required cash on hand much of the production stress is removed from me. Whatever we decide to do with that money once we ve accumulated it, we have to insure that the underlying value is not subject to erosion. That is, if a budget of$ 5, 000 per month is required to support my household, then having around$ 30, 000 cash on hand goes a long way toward making me feel secure financially. for about six months!
To that extent, those strategies and, then/ or trades set aside for our stable money should more or less insure that what ever amount of money we begin with is available to us at any time in the event of a financial emergency. If we buy a$ 55 put and a$ 55 call when the stock price is at or very near$ 55, we re buying AT the money options and should expect to pay around$ 5 or$ 6 for those options having expirations about 4- 6 months hence. Let s continue with our SLAB example. If we buy 10 contracts each, we have about$ 10, 000- $12, 000 invested in the position. To meet MY requirements for six months budget- in- the- bank , I d need three such positions. We need to be very sure that money will REMAIN more or less intact and available to us should we need it. I would certainly NEVER put ALL$ 30, 000 into a single position!
To understand how a neutral position can provide the safety and stability you need, refer to the chart of Silicon Laboratories stock above. Owning a put and a call( at the same strike price& expiration month) is called a straddle, an inherently neutral position. During the last week of January, you ll see the stock gapped up, touching$ 55 that day. Follow the chart as the stock moves down. We ll assume that we entered a$ 55 straddle at that point. If we paid say, $5 for the puts and calls, then we can reasonably expect their premium to change in value as the stock moves.
So, Though the stock has fallen significantly in value, our STABILITY money is still there, ready to be used in an emergency. For example, the stock has, around February 2 fallen to around$ 5Those puts we bought for around$ 5 are now worth around$ 9 or$ 1However, the calls we bought for around$ 5 are now worth around$ No matter, the POSITION value is still worth around$ 10, 000, what we PAID for it! In other words, we could close the position and take our initial investment back at ANY time we wanted or needed to do so. Notice near the end of February, the stock price has risen to around$ 6At that time, our calls have risen to be worth around$ 9 or$ 10 while our puts have fallen in value to around$ Again, we see that our emergency money is STILL intact, despite an almost$ 10 oscillation in the value of the stock. Continue to follow the stock price. We can continue to do that for as long as the stock oscillates.
Stability Induces Safety, Not Profits. . . AND our options haven t expired. Unless. . . Additionally, we ve learned about how straddles work and we ve seen how the strategy produces a safe- haven for some of this stability cash. Up to this point, we ve learned about the importance of having some emergency cash set aside. But wouldn t it be nice if we were to figure out a way to make this money produce a profit in addition to the stability.
Closing the position at either such extreme (up or down) can produce enough profit in the one option to more than pay for the remaining option. Well, a neutral position, strictly speaking will not produce a profit unless the stock moves violently and a long way in either direction. That requires volatility, a concept not closely tied to the idea of stability. That said, there IS a way to pull profits from these positions, and LOTS of it! The biggest benefit of these stable positions is that stability itself, not the lure of profits. However, it requires us to temporarily LEAVE the safety of neutrality by closing out one side of the straddle, remaining in a now" directional trade.
Keep in mind that we can ill afford to gamble with this money! If you sense a bit of increased risk and danger here, you re absolutely correct. We can chase profits in one of two ways. We ll begin with the least time- intensive method. Short term and/ or medium term. Medium term next time in part V. If you think that I might be of help to you in sharpening up your trading skills, please give me a call at my support line, toll free 1- 800- 206- 3935!
See ya then! Make it a great day! Bob Eldridge
