The first strategy many people will see as too risky, but it really depends on your level of education in options, whether you can handle risk and how much spare cash you have to meet your obligation if your puts are exercised. If total cost of exercise is $50 000 and you have money then in case you do get exercised you will be able to buy shares.

Get protection for your shares

Buy Puts Let's say you protect your position by buying a put, then if price drops you will cap your loss, or alternatively, you could sell put/s, which may result in a profit and thus make up for any lost value in share. Covering your position may be an on-going requirement. There will always be a price to pay - that's life!

Making money buying puts

Write Puts If you write puts then you'll be obliged to buy stock in event you are exercised and so having sufficient cash is essential. You can also buy another series to cap your potential loss to spread between two series.

If you wrote $10.00 puts and bought $9.50 puts your loss would be partly covered by having that cover if price drifted lower.

So we can make what looks risky, less risky, by knowing more about what is possible and then choosing our exit strategy. If I am exercised my contingency plan might be to write calls over my new shares and if I preferred, I could go back to put writing, by letting myself be exercised.

If I wanted to keep shares then I would write calls that are further out of money. I can even buy calls in a different series so that in case share price goes up I capture some of increase, or I can cancel contract by buying calls in same series.

During May 2002 I used this same strategy with NCP. I wrote puts at $12.50. I watched share go down to $9.68. I let myself be exercised and met my obligation by paying $12.50/share - risky? You bet, because all worst conditions for put writing came together in June 2002, month I wrote puts.

It fell to $8.44. NCP used to make up 10% of Australian All Ordinary Index, now it is an American stock(NWS), so you could expect such an important stock will get serious attention. However at time big media companies were not flavour of month - all flavours had turned sour!

Following purchase of stock I wrote covered calls. There is nothing wrong with strategy, but timing is your most important variable - thus a contigency plan is required. Keep in mind that 1 month in market is a long time and 3 months is an eternity. Things can change very quickly from panic to ecstacy for no apparent reason. Someone always raises their hand with an explanation to satisfy crowd - wouldn't we be disappointed if someone couldn't tell us. I think we'd probably get very worried!

Writing calls is a good idea when you think stock price will fall. My contingency in event I was exercised was to write calls and make up difference I had lost - I didn't intend buying back calls, as I felt there was little risk of losing stock because $10.50 level would remain out of money.

The resulting action suggested that a better plan would have been to buy/write regularly - buy calls back sheep(cheap) and write deer(expensive). Waiting first for stock to peak then writing call.

I could have closed out my contract by purchasing puts in same series. I could have bought puts in another exercise price series to cap my loss. I chose a different way and regretted my choice. Holding stock was not easiest choice I could have made and in fact it held me back from making a lot more money.

Once I had stock I had to protect it. If I then sold protection I could have found stock slipping further in value, so I kept protection in place and missed profit as stock moved back up. So even though I inially lost by having been exercised I lost more by not being in a position to be more flexible. A further complication was my stock was purchased with a margin loan.

What should I have done?

I could have sold protection , made a profit and then looked at buying same protection cheaper. I could have done this at least 4 times in 4 months.

This brings us to topic of increasing flexibility of our thinking.

If you make money only in one direction you will reduce your trading results drastically. The market does not always go up! Sometimes it goes down or moves sideways.

We all need to be on right side of market. Believe me alternative is no fun!

Happy Trading, Joseph Sgro

_______________________________________________________________ Copyright(C)2003 Joseph Sgro Further this discussion by reading: "10 Simple Rules to Make Serious Money in Sharemarket and Keep it!" http://www.tutorhelp.com.au/sharemarket.html

For more articles: http://www.tutorhelp.com.au/articles.html ===============================================================

Joseph Sgro has spent a good slice of the last 20 years as an educator and 16 years as a trader.