How to Protect Your Portfolio as the Market Slumps

I was going to write about Chinese gambling stocks today, but given the recent 5% decline in the market I thought all of you would appreciate an article that truly works to keep hard-earned money in your pocket.
The S&P 500 closed the year up 29.6 %…the best year for stocks since 1997. Since the calendar has flipped to 2014, however, stocks have struggled. Is it the sign of a long-expected correction? Or is it the latest in a string of false alarms – mini pullbacks that last little more than a month?
As we near the five-year anniversary of the latest bull market run, I can’t help but  remind everyone that the market is over 135% higher since the low established in early 2009. So, a pullback should not be unexpected…and I want to show you how to keep your profits without having to sell your stocks.
Stocks like Netflix (Nasdaq:NFLX), LinkedIn (Nasdaq: LNKD), Chipotle (NYSE: CMG) and many other have benefitted from the relentless surge.
Is it time to sell a few of these high-flyers or just stocks in general?
Well, let’s take a look at one of the biggest bull benefactors and a personal position of mine, Elon Musk’s Tesla (Nasdaq:TSLA).
Back in late December 2012, on a recommendation from a friend, I purchased 100 shares of Tesla for my seven year-old daughter. I NEVER, and I must emphasize NEVER, buy stocks based on the recommendations of others. But my friend is the ultimate perma-bear. He would much rather short a stock than buy one. But, for the first time, at least since I’ve known him, he highly recommended buying a stock. The stock…Tesla.
The timing happened to be just right because I had some capital set aside for my daughter and was searching for a few stocks to invest in. So, I bought a few hundred shares thinking I would hold on to the stock for a few years.
But then the stock started to rise, well, exponentially.
Surprisingly, I was able to hold on to the stock as it continued to gain more and more momentum. As an options trader, the typical holding period is days, sometimes hours, but in this case the stock was purchased as a long-term holding.
But the struggle to not sell the Tesla continued as the stock became more and more overextended. And then a video surfaced back in early October of a Tesla Model S sedan that had burst into flames. Finally, too concerned to ignore the situation, I did what any sound options strategist and savvy investor would do; I added some downside protection.
As a quick aside…I realize that as soon as I mention options most of you immediately tune out, but not learning how to appropriately protect your investments can cost you thousands upon thousands of hard-earned dollars.
Why would you not want to learn a simple strategy that allows you to protect gains in your portfolio without jeopardizing too much of the upside potential left in the stock?.
I used a simple options strategy known as a collar.

The Collar = (long stock + short call + long put [with different strikes])

To build a collar, the owner of 100 stock shares buys one put option, which grants the right to sell those shares at the put’s strike price.  At the same time, the stock holder sells a call option, which grants the buyer the right to buy those same shares at the call’s strike price.
Because the investor is paying and receiving premium, the collar can often be established for zero out-of-pocket cash, depending on the call and put strike prices. That means the investor is accepting a limit on potential profits in exchange for a floor on the value of their holdings. This is an ideal tradeoff for a truly conservative investor.
So, on Oct. 2, I  decided to use a collar on Tesla with the stock trading around $180. I wanted to protect a loss in the stock of no more than 20%…a typical bear market move.
I bought $145 puts for $15.25 and sold $220 calls for $15.50, which actually gave me a credit of $0.25 or $25. Basically my loss was limited to move down to $145. Any move more than that and I was covered by my position.
Due to the unrelenting rally, I had $18,000 in TSLA shares when I opened the collar.
But roughly a month later TSLA closed at roughly $151, down roughly 16% from the price at which I added the collar.
Here is where my collar stood. The puts were worth $19.45 and the calls were worth $4.20. So, if I wanted to close the short call leg of the collar it would cost me $420. By doing this I am left with my put position worth $1,945.
So what’s my loss?
If you take the $15,100 the shares were worth last Wednesday plus the $1,945 the puts were worth, you have a total of $17,045. But remember, we bought back the calls for $420 so we have to subtract that from the $17,045 which gives us a total of $16,625.
The $16,625 represents a loss of 7.6% loss from the $18,000 our TSLA position was worth when we added the collar. That’s far superior to the 16% loss we would have taken if we had no hedge on the position.
Being hedged gave me the breathing room to decide the best course of action. My TSLA position hedged with a collar could allow me to exit my position with an 8% loss now, or I could wait to see what happens, or if I was still bullish on TSLA, I could buy-to-close the call leg of this collar, to eliminate my upside cap. If I was even more bullish after the decline, I could sell my appreciated puts, and use those proceeds to buy more TSLA.
Given the recent advance in many of the high-flyer stocks like LinkedIn, Netflix and many others, now might be the ideal time to start looking towards a collar to keep your hard-earned gains in your pocket.

My Gameplan for the Year Ahead — Earn $1,200 a Month

If you missed Andy Crowder’s latest options webinar… don’t worry. We’ve uploaded a full, on-demand recording of the event on our site. During this video, you’ll discover exactly how he’s planning to make consistent profits in 2014, no matter which direction the market moves. Including, free action-specific trades you can execute immediately — gains you can earn in as little as 15 to 28 days! You’ll also get his entire presentation, including the lively Q&A session. Options videos and courses can run as high as $999, but this 60-minute presentation is completely FREE. Click here to watch this video now.

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