Stock Insurance Policy by Sylvain Vervoort
Here’s how you can ensure your positions in stocks by
combining them with options.
There are certain facts about buying stocks, among
Fact 1: When the price of a stock is making a longterm
up move, the only mistake you can make is to buy that
stock at the wrong time by just looking at the short term.
Fact 2: To hold a position during a longer-term price up
move of 30% or more, shorter-term price reactions of 10% up
to 13% (for the more volatile stocks) must be accepted.
From the chart of Salesforce.com (CRM) in Figure 1, it is
likely you will be tempted to buy the stock after the February
2006 correction and the price breaking above the red descending
The blue dashed line is a 12% trailing stop. Using such a
liberal stop kept us in the trade until a top at the beginning of
February, when a third sharper uptrend line was broken. A
number of days later, the 12% trailing stop was broken by the
closing price for the first time since the start of the uptrend at the
end of August.
Fact 3: You should accept the fact that 50% of your trades are
going to lose money. Figure 2 clearly shows that it was not the
right time to buy CRM.
Fact 4: If 50% of your trades are making a loss
of 10%, then the profitable trades must make
around 25% to end up with a high-enough
Fact 5: When applying good money management,
the money lost in one single trade should
not exceed 1% to 2% of the total trading capital.
Since you have to risk up to 13% of the
investment when opening a position, wouldn’t
it be nice to have some form of insurance that
would always limit the loss to that level, no matter
what happens within a certain time period?
OPTIONS INSURANCE POLICY
Using put options as insurance right from the
start when buying stocks lets you sleep at night
because you know beforehand exactly what
risk you are taking. This strategy is referred to
as a synthetic long call.