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In Part 4 I
will present
a
protection strategy of put buying to protect against a
possible dividend cut and/or a severe pull back in a stock
or a stock market panic or market meltdown.
I will again use
General Electric Stock for my example. Take time to study
the trade example and consider how by buying a put, it could have protected
against a decline in Citicorp stock, AIG stock, Bank Of
America stock and a host of others in the most recent stock
market panic.
Many investors including long
term dividend investors do not believe in any form of insurance for
stock investing. Yet with many stocks, protection is readily
and often cheaply available through buying put options.
A put option simply gives an investor the right to sell or
put his shares to someone else at the price the put buyer
has bought. Many investors do not understand that a stock
put offers cheap insurance for a
catastrophic event. Since the put option is for catastrophic
insurance, it can be purchased for just a few cents by the
dividend investor select to buy puts far out of the money. This cheap
put buying insurance establishes a floor under the
losses an investor is willing to take in the event of a bear
market or a major collapse in the stock.
In many cases, the cost of buying puts can
easily be covered by a single dividend payment. This form of
catastrophic insurance is often overlooked by long term
dividend investors, but it can often save a dividend
portfolio from severe damage and should be given serious
consideration as part of an overall dividend investment
strategy.
I will again use General Electric Stock as an example.
For any sell dates I will use May 27 2011 at $19.47.
No commissions are taken into account for any of the trades
shown here. Let us see how the trades worked out when put
options are purchased as insurance.
The cost for the puts are courtesy of a friend
who has traded in General Electric Stock for more than 20
years. He always purchases "catastrophic insurance" through
buying puts. I have used his actual put buying in the
examples.
STRATEGY: BUYING PUTS FOR PROTECTION
YEAR 1 - 2001
Low of 2000 was $41.69
On MAR 12 2001 the stock reached $41.69. 100 shares are
bought for a cost of $4169.00
Dividends Earned To May 27 2011 on these 100 shares is - $852.00
PUT OPTION PROTECTION ACTIVITY FOR 2001:
On April 20 2001 the stock closed at $43.83. The following
day I purchased 1 put for January 2002 at the $35.00 strike
for .15 cents
Total cost of Put protection was $15.00
On Sept 21 2001 GE fell from $32.51 to $28.50 and closed at
$31.30. As this is a long term buy and hold investment, I
sold my put during the day for $5.40. Total earnings from
the PUT SELL - $540.00
END OF YEAR SUMMARY
At the end of the year I am holding 100 shares of GE Stock
which cost $4169.00
Put Protection Cost - $15.00
Put Income On Sell Of Put - $540.00
YEAR 2 - 2002
Low of 2001 was $28.50
On JULY 2 2002 the stock reached $28.50. 200 shares
are bought for a cost of
$5700.00
Dividends Earned To May 27 2011 on these 200 shares is $1500.00
Since $28.50 is a new low for my overall portfolio in GE, I
purchased an additional 100 shares
PUT OPTION PROTECTION ACTIVITY FOR 2002
On Feb 25 2002 GE closed at $39.45. I bought 1 put contracts
for JAN 2003 at the $30.00 strike for .25 cents.
Total cost
for the put protection was $25.00
On Aug 5 2002 the stock closed at $32.40. The following day
I purchased 2 puts for January 2003 at the $25.00 strike for
.15 cents
Total cost of Put protection was $30.00
On Sept 30 2002 GE fell to $23.51 and closed at $24.65. The
following day I sold the Jan 2003 $30 strike for $5.30.
Total earnings from the PUT SELL - $530.00 . I held onto the
second put which I had bought at the $25.00 strike.
On Oct 9 2002 GE stock closed at $22.00. The next day I sold
my two Jan 2003 $25 puts for 3.30. The total earnings from
the PUT SELL was $660.00
END OF YEAR SUMMARY
At the end of the year I am holding 300 shares of GE Stock
for a total invested capital of $9869.00
Put Protection Cost - $55.00
Put Income On Sell Of Put - $1190.00
YEAR 3 - 2003
Low of 2002 was $21.40
On FEB 13 2003 the stock reached $21.40. 200 shares are
bought for a cost of $4280.00
Dividends Earned To May 27 2011 on these 200 shares is $1426.00
Again, since $21.40 is a new low for my overall portfolio in
GE, I purchased an additional 100 shares.
PUT OPTION PROTECTION ACTIVITY FOR 2003
On April 28 2003 the stock closed at $29.03. The following
day I purchased 3 puts for January 2004 at the $20.00 strike
for .15 cents. This left 200 shares unprotected from a
severe pullback.
Total cost of Put protection was $45.00. For the rest of the
year the stock stayed well above my $20.00 put strikes. The
puts
expired worthless in January 2004.
END OF YEAR SUMMARY
At the end of the year I am holding 500 shares of GE Stock
for a total invested capital of $14149.00
Put Protection Cost - $45.00
No Put Selling Occurred
YEAR 4 - 2004
Low of 2003 was $21.30
Throughout 2004 the stock stayed above $21.30. The investor did not buy
any shares
PUT OPTION PROTECTION ACTIVITY FOR 2004
On January 21 2004 the stock closed at $33.85. The next day
I bought 5 Puts for January 2005 at the $25 strike for 18
cents. Total put cost - $90.00
During 2004 no puts were sold and I bought no additional
stock.
END OF YEAR SUMMARY
At the end of the year I am holding 500 shares of GE Stock
for a total invested capital of $14149.00
Put Protection Cost - $90.00
No Put Selling Occurred
YEAR 5 - 2005
Low of 2004 was $28.88
Throughout 2005 the stock stayed above $28.88. The investor
did not buy any shares
PUT OPTION PROTECTION ACTIVITY FOR 2005
On February 1 2005 the stock closed at $36.28. The next day
I bought 5 Puts for January 2006 at the $25 strike for 12
cents. Total put cost - $60.00
During 2005 no puts were sold and I bought no additional
stock.
END OF YEAR SUMMARY
At the end of the year I am holding 500 shares of GE Stock
for a total invested capital of $14149.00
Put Protection Cost - $60.00
No Put Selling Occurred
YEAR 6 - 2006
Low of 2005 was $32.67
On JAN 25 2006 the stock reached $32.67. 100 shares are
bought for a cost of $3267.00
Dividends Earned To May 27 2011 on these 100 shares is $463.00
Since $32.67 is NOT LOWER than the all time low of $21.40 I
only bought 100 shares
PUT OPTION PROTECTION ACTIVITY FOR 2006
On January 11 2006 the stock closed at $35.43. The next day
I bought 5 Puts for January 2007 at the $25 strike for 18
cents. Total put cost - $90.00
I purchased just 5 puts as on January 11, as I did not have
the additional 100 shares until Jan 25.
However as the puts are insurance I elected not to purchase
1 additional put after buying the 100 shares as I felt 5
puts was enough.
During 2006 no puts were sold.
END OF YEAR SUMMARY
At the end of the year I am holding 600 shares of GE Stock
for a total invested capital of $17416.00
Put Protection Cost - $90.00
No Put Selling Occurred
'
YEAR 7 - 2007
Low of 2006 was $32.06
Throughout 2007 the stock stayed above $32.06. The investor did not buy
any shares
PUT OPTION PROTECTION ACTIVITY FOR 2007
On January 3 2007 the stock closed at $37.97. The next day I
bought 6 Puts for January 2008 at the $30 strike for .22
cents. Total put cost - $132.00
During 2007 no puts were sold.
END OF YEAR SUMMARY
At the end of the year I am holding 600 shares of GE Stock
for a total invested capital of $17416.00
Put Protection Cost - $132.00
No Put Selling Occurred
YEAR 8 - 2008
Low of 2007 was $33.90
On JAN 17 2008 the stock reached $33.90. 100 shares are
bought for a cost of $3390.00
Dividends Earned To May 27 2011 on these 100 shares is $276.00
*Again since $21.40 is the all time low so far in my
investment in GE stock, I only bought 100 shares
PUT OPTION PROTECTION ACTIVITY FOR 2008
On February 1 2008 the stock closed at $26.16. The next day
I bought 7 Puts for January 2009 at the $30 strike for 29
cents. Total put cost - $203.00
During 2008 the stock fell during the fall. I held the puts
throughout the year as by the fall I was becoming concerned
for GE Stock
END OF YEAR SUMMARY
At the end of the year I am holding 700 shares of GE Stock
for a total invested capital of $20806.00
Put Protection Cost - $203.00
No Put Selling Occurred
YEAR 9 - 2009
Low of 2008 was $12.58
On JAN 21 2009 the stock reached $12.58. 200 shares were
bought for a cost of $2516.00
Dividends Earned To May 27 2011 on these 200 shares is $242.00
*Since $12.58 is lower than $21.40, I bought an additional 100 shares
*$12.58 is now the all time low on my GE Stock Portfolio.
On February 27 2009 GE announced they were cutting their dividend.
The day
after I bought 200 shares at $7.60. Total cost $1520.00 -
Dividends earned to Date - $180.00
$7.60 is now my new all time low on my GE Stock Portfolio.
PUT OPTION PROTECTION ACTIVITY FOR 2009
On January 16 2009 the January options expired. The low of
the day was $13.06 and the stock closed at $13.96 I sold the
7 puts for $16.15
Total Put Income was $11,305.00
On January 20 2009 GE stock opened at $13.95 moved to a high
of $14.09 and the stock then fell to close at 12.93. Put premiums are
really high. At this stage I really cannot believe GE can
fall much further. I decided to not purchase puts yet. This
was a mistake. The stock continued falling.
On May 7 2009 the stock closed at $13.96. Puts are still
overpriced. Since I made quite a bit with the puts back in
January I am holding still holding off on buying more puts.
The market appears in a recovery mode. GE has more than
doubled since its low in March.
On September 22 2009, GE Stock closed at 17.01. The next day
day I bought 5 puts for January 2010 $12.00 for 18 cents.
Total put cost was $90.00
END OF YEAR SUMMARY
At the end of the year I am holding 1100 shares of GE Stock
for a total invested capital of $24842.00
Put Protection Cost - $90.00
No Put Selling Occurred
Put Income On Sell Of Put - $11,305.00
YEAR 10 - 2010
Low of 2009 was $5.67
Throughout 2010 the stock stayed above $5.67. The investor
did not buy any shares
PUT OPTION PROTECTION ACTIVITY FOR 2010
On January 15 2010 the January options expired.
On April 13 2010 GE Stock closed at $18.95. The next day I
bought 5 puts for January 2011 at $12.50 for 21 cents for a
total cost of $105.00
The puts were not sold and expired in January 2010.
END OF YEAR SUMMARY
At the end of the year I am holding 1100 shares of GE Stock
for a total invested capital of $24842.00
Put Protection Cost - $105.00
No Put Selling Occurred
YEAR 11 - 2011
Low of 2010 was $13.75
To date in 2011 the stock has stayed above $13.75. The
investor did not buy any shares.
PUT OPTION PROTECTION ACTIVITY FOR 2010
On Feb 14 2011 the stock closed at $21.50. The next day I
bought 5 puts for January 2012 at $15.00 for 28 cents for a
total cost of $140.00
To date the puts have not been sold.
END OF YEAR SUMMARY
At the end of the year I am holding 1100 shares of GE Stock
for a total invested capital of $24842.00
Put Protection Cost - $140.00
No Put Selling Occurred To Date
TOTALS
Number of Shares: 1100 shares
Total Capital invested in GE Stock - $24,842.00
Average share price - $22.58
Dividend Income Earned since Jan 2 2001- $4939.00
Put Protection Cost - $1130.00
Put Sell Income - $13035.00
COST BASIS - $24,842.00 plus $1130 put protection cost,
minus $4939 in dividend income, minus $13,035.00 in put sell
income = $7998.00 / 1100 shares = $7.27 per share.
The benefits of this put buying dividend
investment strategy for catastrophic insurance
is obvious. Two bear markets more than paid for the cost of
the insurance and the long term investor is left with the
stock at a cost basis of $7.27. Despite the collapse
of General Electric, the dividend investor is still holding
1100 shares, gathering the reduced dividend, and has had no
damage done to his dividend stock portfolio.
SUMMARY OF
PUT BUYING DIVIDEND INVESTMENT STRATEGY
Buying put options for protection makes a lot of sense.
It should form a basis for every dividend investment
strategy. For the average dividend investor, it provides a level of
comfort not unlike mortgage, home or car insurance. For a
small annual fee, which for dividend stocks is often offset
by a single dividend payment, an investor can purchase long
term, out of the money insurance to guard against a
disaster and protect his dividend stock portfolio. The
advantages of put buying are obvious particularly during
bear markets or periods when the stock market is stocks or
under pressure.
'
