Money Protecting Tips

How to Protect Your Money in Stocks

Does the stock market make you feel queasy? Have you put your hard-earned money into the stock market only to see it vaporize in front of your monitor? After researching hard and long, I have finally found one method using which you can protect your money. Consider the scenario below.

Say, you put $10,000 into company XYZ's stock because your research tells you that this stock has upside potential. Now begin endless sleepless nights followed by endless checking of that stock price every day. The price moves sideways, up or mostly down (Murphy's law!). The value now sits at $9,000...$8,500...$7,800. How low can you see it go? Can anyone (or anything) guarantee that you will recoup your money later? NO ONE. Except my trick!

Here Is The Trick

The answer lay right "under my nose." It is the same as buying insurance. You simply buy insurance for your stock. If the stock goes up, you end up making money (less the small premium you paid for the insurance). If the stock goes down, you collect the difference and exit the position. If the stock price stays the same and you still believe that the stock has potential, you renew your insurance term, or you exit the position fully.

The technical name for this insurance is "options." Now, this word may scare you. But, this technique is as simple as it gets and is a surefire way to protect your capital.

Example: Say, your research indicates that Microsoft stock will go up to $30 by Oct 2005. So, you buy 400 shares of MSFT (in Jun 2005) costing $10,000. You turn around and buy "PUT" options on 400 shares. Options are sold in contracts; one contract is for 100 shares of the underlying stock. Therefore, you buy 4 "PUT" contracts with a strike price of $25. In other words, you buy insurance for (4*100=400) shares, which guarantees that you will get back your money by October '05 should the stock price dip below $25, less the cost of the options.

Now, the cost of the option is $0.90/share, which means it costs you $0.90*400 = $360 to protect your $10,000 investment. Now you can sleep peacefully at night because even if the stock dips to $3 (that will be a bad day in the market), you will get paid the difference (=$25-$3=$22, $22*400=$8,800) + you get $1,200 when you exit your position for a total of $9640 ($10,000—$360) come October '05. While others less fortunate get butchered in the bloodbath, you walk away with nary a scratch. Smart.

I suggest a little more reading on this topic. Please talk to your stock broker or a professional BEFORE you take action (for your own sake).

Let me know how this works out for you (vick at usabletips.com).