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Options vs Stop Losses?

  1. Jul 28, 2009 #1
    Through this downturn I've seen so many analysts suggest stop losses as a way to minimize risk. The strategy works like this. Your stock falls bellow the amount you are willing to lose then you sell. This to me sounds like buy high and sell low which is the exact opposite of what you want to do if you want to make money.

    So alternatively, I wondered, if you are concerned about losing money why not buy some kind of option (a "put" to be specific) that lets you sell at a given price. That way no matter how far the market falls, you have the option of selling at the price you bought the option for. Anyway, when I looked at the numbers for one stock bellow and this strategy didn't seem too hot either.

    So how much will this insurance cost you. Well, I chose IBM as a random stock. Here is the current stock price:

    Last: 117.09 Change: -0.54 Volume: 5,120,042

    Here are the quotes on puts:

    Code (Text):
    Strike Price    Symbol  Last    Chg %Chg    Time Value  Bid Ask Vol Open Interest
    65.000  .IBMTM  NA  NA  NA  NA  NA  0.050   NA  NA
    70.000  .IBMTN  0.070   NA  NA  0.050   NA  0.050   NA  160
    75.000  .IBMTO  0.050   NA  NA  0.050   NA  0.050   NA  334
    80.000  .IBMTP  0.020   NA  NA  0.050   NA  0.050   NA  451
    85.000  .IBMTQ  0.050   NA  NA  0.050   NA  0.050   NA  3,049
    90.000  .IBMTR  0.050   +0.01   +25.00% 0.050   NA  0.050   213 1,633
    95.000  .IBMTS  0.080   +0.03   +60.00% 0.100   0.050   0.100   65  4,775
    100.000 .IBMTT  0.100   -0.05   -33.33% 0.150   0.100   0.150   2,440   7,254
    105.000 .IBMTA  0.300   unch    unch    0.300   0.250   0.300   349 8,013
    110.000 .IBMTB  0.800   +0.05   +6.67%  0.800   0.750   0.800   1,598   8,386
    115.000 .IBMTC  2.050   +0.15   +7.89%  2.100   2.000   2.100   3,108   8,074
    120.000 .IBMTD  4.780   +0.47   +10.90% 1.890   4.600   4.800   755 2,511
    125.000 .IBMTE  8.900   -0.10   -1.11%  0.990   8.700   8.900   333 976
    130.000 .IBMTF  13.400  +0.10   +0.75%  0.690   13.500  13.600  10  757
    135.000 .IBMTG  18.300  +0.40   +2.23%  0.690   18.300  18.600  2   107
    140.000 .IBMTH  23.000  NA  NA  0.790   23.200  23.700  NA  33
    145.000 .IBMTI  28.000  NA  NA  0.790   28.200  28.700  NA  20
    http://moneycentral.msn.com/investor/options/default.asp?symbol=ibm

    The option contracts tend to last for about a month. So say we don't want to lose more then 20%. Then our stock should not fall by a factor of more then 0.8 per year or (0.8)^(1/12)=0.9816. The current price multiplied by 0.9816 is 114.935544

    The closest strike price to this is 115.00. The asking price is 2.100.

    The asking price for this option is 1.8 % the price of the stock. Therefore to protect against a 1.8% loss in a month we would need to buy an option worth 1.8% the value of the stock.

    This doesn't sound two effective, unless you consider there is a good chance of the stock jumping much more then 1.8% in a month. Not sure when this would happen. Maybe in a rally after a dip. Maybe if I consider some other scenarios it might work better.
     
  2. jcsd
  3. Aug 1, 2009 #2

    BWV

    User Avatar

    there ain't no free lunch

    you have to assume that derivatives are fairly prices, otherwise why would a knowledgeable trader sell them to you?

    stop losses are also problematic as prices are not continuous - they can gap down well in excess of the stop price.
     
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