How To Have A Safe Investment Strategy

November 9, 2010 | By | Reply More

During the last few months we have frequently urged our readers to look out for pull-backs in the gold and silver spot prices and  then take the opportunity to increase their exposure to these metals with any spare cash that they may have.

Of course we appreciate that it is a rare occurrence for the ordinary ‘man in the street’ small investor to catch the bottom of a market downturn  when buying but there are ways and means to avoid making a buying decision that may turn out to be an expensive error of judgement for those with limited investment funds, so leaving them short of cash when they next spot a potential winner.

This is a reason why a safe investment strategy is so important to the small investor.

Fair Value Investment

This writers’ long term strategy is to remain fully invested at virtually all times. In practise this means that when my pre-planned target price is hit on a position I hold, I sell and look to reinvest the proceeds a.s.a.p., hopefully in the same session.

As I am by nature a long term investor with just a hint of an inherited gambling streak, nine times out of ten it is of little consequence whether I buy or sell at the top of the market or buy and sell at the bottom.

The overriding criteria is make the right investment at fair value with an eye to future performance justifying the target price at which I intend sell.

The Safety First Gamble

This means that I have limited resources to indulge my tendency to gamble. Fortunately the Option market has come to my rescue and allowed me to play the short term

markets without jeopardising my long term objectives by having to prematurely sell good investments to fund the inevitable losing streak.

GLD & SLV Options

As precious metals, particularly gold and silver, are the market sector I take most interest in, most of my speculative moves have been to buy ‘calls’ or ‘put’ options in either Ishares Silver Trust (SLV) or SPDR Gold Trust (GLD), neither of which were available only a few short years ago.

Over 50% of my investment capital is in the precious metal and mining sector all of which are showing great returns with, I believe , a lot more to come. Along the way there will be significant fluctuations, as there has been already, but I fully expect the bull market ‘wall of worry’ to be successfully climbed for several years yet.

Puts & Calls Can Be a Profitable Strategy

So why can buying call or put options be a successful strategy for those with limited cash resources? Let me give you a recent personal example. On the 25th October I felt that SLV was overbought and that a correction was taking place.

I put in a limit order to buy the April $24.00 call at £1.74, which turned out to around the bottom but missed the market as my computer played up. By the time I got it sorted the price had risen to $1.80, not a lot more than my limit buy price but breaking my self- imposed discipline of sticking to my targets.

I kicked myself, then the computer, but left the order outstanding, not expecting it to get filled. To my surprise on the 27th, just when I thought the market had left me behind, the order was filled when SLV fell to $22.87.

Profitable Trade

Today, only nine trading days later, I sold half my calls at $5.50 leaving me trousering $202.00 profit per contract sold (less commission) and owning calls that stand me in at zero.

I now have the choice of selling more of my calls as the market either moves up or looks like it is pulling back, either way will still show more profit and even if  silver becomes  completely worthless I have still made $202.00 a contract. If I have sufficient funds I can increase my long term SLV holdings at the strike price of $24.00.

A win win win situation!!

Comparing Profit, Loss and Capital Commitment

If the market had turned against me and SLV tanked to $0.00 my total losses in the unlikely event of a wipe out would have amounted to only $174 .00 a contract, whereas if I had bought only 100 shares at the strike price my loss in an unlikely total wipe-out would be $2287.00.

Set this against a maximum profit today of circa $560 by selling those 100 shares. This kind of strategy using options can work for any reasonably volatile stock and works equally well if you expect your chosen stock to reverse after hitting a high. Buy the put at a strike price near the top.

Options are Easy to Deal

If you do not like the look of your original opinion options are easy to deal in so cutting losses is only a decision making problem. We use www.optionXpress.com which is easy to navigate, full of useful information and tutorials, inexpensive dealing charges and we love the speed, just wish our computer would keep up.

Simple Explanation Of Terms

For the benefit of the uninitiated, the purchaser of a ’call’ option has the right to buy the stock at the strike price.

  • A  purchaser of a ’put’ option can sell the stock at the strike price.
  • The strike price is the dealing price to buy or sell 100 shares before the option expiry date.
  • The expiry date is a given date after which the option becomes void and worthless.
  • Each option contract is for 100 shares.

Helpful Tips

Look for cheap options, that is selling for less than circa $2.00 a contract. Be very aware of the option expiry date. Factor in ‘time decay’ in your decision making.

As time passes so the depreciation of your option will accelerate if on the wrong side of a break even strike price. The longer you wait the more you will lose if on the wrong side of the trade. Don’t be tempted to sell  call or put options you don’t own until you are very experienced.

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