Back in January I discussed that I was jumping in with the bears on a particular stock and actually betting that a company would be worth less than what it was at a future date. In that post I discuss the difference between the two main options I knew about when trying to profit off a falling company – Shorting a Stock and Buying a Put.
To give a quick recap:
According to Investopedia when you short a stock,
…your broker will lend it to you. The stock will come from the brokerage’s own inventory, from another one of the firm’s customers, or from another brokerage firm. The shares are sold and the proceeds are credited to your account. Sooner or later, you must “close” the short by buying back the same number of shares (called covering) and returning them to your broker.
This risk was always way too high for me. If the stock took off in the opposite direction (i.e. was worth more) my risk could be theoretically unlimited (although I would probably have to “close” a lot sooner). Side note: when too many people are closing out their shorts because the stock price is increasing it is called a short squeeze.
So with that being the only way to bet against a stock I never traded on my gut that a stock was going down in price…that was until I learned about a particular option play. Better explained by The Chicago Board Options Exchange in their fantastic introduction on the topic of buying puts:
Buying an equity put gives the owner the right, but not the obligation, to sell 100 shares of underlying stock at a specified price (the strike price) at any time before a specific time (the expiration date). This is a bearish strategy because the value of the put tends to increase as the price of the underlying stock declines. This gain in option value will increasingly reflect a decline in the value of the underlying shares when the stock’s market price moves below the option’s strike price.
The profit potential is significant as the underlying stock continues to decline, and is limited only by a potential decrease in the stock’s price to no less than zero. The financial risk is limited to the total premium paid for the option, no matter how high the underlying stock increases in price. Investors find this limited risk more attractive than the unlimited upside risk incurred from selling 100 shares of stock short. In addition, a short seller of underlying shares must pay any dividends distributed to shareholders while the short position is held; a put holder does not. The break-even point is an underlying stock price equal to the put’s strike price minus the premium paid for the contract. As with any long option, an increase in volatility has a positive financial effect on the long put strategy while decreasing volatility has a negative effect. Time decay has a negative effect. emphasis added.
My Experience and Numbers Behind Buying a Long Put Option
I didn’t want to provide the name of the equity prior to it closing out, but the company I was investing against was Lululemon. I listed the reasons in that original post
1) because analysts have already seemed to turn;
2) the company has already said they missed estimates
3) the company is already valued at a 40+ P/E and
4) the company, in my opinion is a fad.
So I put my money where my mouth was and bought a long put option against Lulu:
What the above order confirmation is saying is that on January 17, 2013 I bought two puts that expires(expired) on June 22, 2013 for a total cost of $1,389.53 ($6.90 was the contract price). So if the stock on June 22, closed:
- Above $67.50 I was out nearly $1,400
- Below $60.60 excluding fees I was making some cash!
- In between that amount I’d be loosing some of my $1,400 but the closer I came to that magic $60.60 number (a little below when we take into account fees) the less I would be losing.
Well, it was a bumpy ride to say the least. First I was the smartest man to ever live:
I mean inside two months the company dropped over 6% – it was only March and I was basically already there. Another two months to go? Hell I was already making it rain somewhere. The reason was that the company had shipped some see through pants and for some reason STILL unknown to me this was a bad thing.
and then the bad times set in:
Yeah then it went on a MAD dash to over $80! The making it rain party was no more? Hell I was thinking I was going to have to go dance somewhere for quarters since no one is paying me with whole dollars to dance. And then I got really really really lucky:
The stock plummeted when the CEO-Founder suddenly announced her future resignation and earnings weren’t as good as expected.
End Result of the Trade
I had to buy 200 shares of Lulu (so I can “put them to someone else” at the higher price).
So, we take the difference between these transactions $1,239.04 and take into account what it cost me to execute the trade $1,389.53 (all fees included) and we have a final loss of $150.49. Much better than the $1,389.53 loss I was looking at when the bad times hit lol.
Would I Purchase a Long Put Strategy Again?
About a year ago I decided to put some money towards an investment idea I had been thinking about for years. I was going to buy stocks for the sole purpose of selling covered calls on them. My thought process was simple enough:
- Buy equities that were near option call levels
- Sell a covered call at a price that was predetermined to be an acceptable gain for me
- Use premium to buy different equities
If the stock got called then I received my premium plus the gain that I already accepted as my maximum profit. If the stock didn’t get called away then I would just do it again (and again and again) with the same equity position. During that time I also bet against my first stock using a put strategy.
As far as the covered call strategy I still believe in it 1000%, but I think I implemented it incorrectly. My focus was to,
find companies with a market cap of at least $200 Million, a positive P/E, a stock price of below $5.00 per share and are traded on the options exchange. From the remaining companies I will research them one by one to determine whether to move on any of the options available. The covered calls will be out of the money options that will expire within 0 to 6 months of purchase. The strike price will be an amount that I am very okay profit-wise
Not once do I discuss the underlying business because it didn’t matter to me…and that was/is a mistake. The reason the stock price had to be low was because I needed enough cash to buy the underlying stocks to sell the calls against. At this point I would call this speculation at best, and at worst, gambling.
When I finally roll out of the outstanding contracts I will provide an accountability report as I always do. My plan is that once the contracts come due I will sell the underlying stock at market value and look into picking up passive index investing.
Why passive index? Because I have active funds in my hated 401(k) and a non-qualified dividend portfolio (my favorite asset), so I feel like just taking this account off the table for a very long time.
Again, I want to revisit this investment strategy one day, but when I do I will do it correctly.
I had the sudden urge to go through my ever growing mail pile on my kitchen table (that urge may or may not have been nurtured by The Wife). In that pile were 3 credit cards I had to activate due to the old ones being expired. Currently, The Wife and I only use 2 credit cards and the rest sit dormant; this is a far cry from when I needed a “credit card booklet” created to keep track of all my cards. Opening the booklet, seeing the cards that had expired as well as those cards that I haven’t used in literally years brought back some odd feelings about how much my financial life has changed in the past 4 or 5 years since I started this blog.
I say “start this blog” because that was my true financial awakening. It is literally the moment when I decided that I had to get intentional about my finances. I think most people’s gut reaction is to say, “you were already 26 and a homeowner maybe that should have happened sooner” but considering the average household in America spends almost every dollar it takes in I would say you could be 62 and still be ahead of the game when it comes to intentionally fixing your financial household.
My first sentence ever written on My Journey to Millions was,
I figured I needed to start somewhere so why not lay it on the line for the readers of this blog, while keeping myself accountable in the months and years to come.
Kind of creepy that accountability found itself through the blog even years later.
How My Finances Have Changed over the Years
Credit Card Debt
That first post included a piss poor debt overview,
- Approximately $16,800 in Credit Card Debt!
- Approximately $250,000 in Secured Debt (House Mortgage and my car – wife leases)
- $60,000 – $70,000 Law School Loans
It wasn’t until the end of that first month that I provided a real insight into my credit card debt
|Bank of America (VISA)||1,344.97||1,359.84|
Want to know something weird? I wish those balances were even higher! A large percentage of our credit card debt was due to our honeymoon in Greece. The Wife and I celebrated our 5 years on June 14, 2013 and I still think about how much I would have LOVED to extended our honeymoon. Now with our awesome boy, I can’t even begin to image a time where The Wife and I get away for 2+ weeks to anywhere nevertheless Europe.
Who Handles the Household Finances
Another thing that has changed is where The Wife and I ended up in terms of controlling our finances. The Wife basically supported herself with regards to her cash flow from the day she graduated college until the day we bought a house while I on the other hand wanted full control of our finances. It was until 6 months after this blog that a plan was finally implemented for our money. This basic flow chart still exists today. The difference? I run everything. It isn’t to say we aren’t partners, it is just to say that she doesn’t worry about this part of our lives unless I bring it up to her.
Net Worth and Assets
This is where the most change has happened financially. While I am no where near my goal I am a hell of a lot closer than I was when I had a very negative net worth at the age of 26. Lately, I have been feeling frustrated just how far I am from my initial goal (i.e. the name of the site) but a post like this reminds me where I started.
I was talking to a colleague the other day who happened to open up a restaurant when he reminded me of the most important thing to understand and know before you start ANY business. It wasn’t the point of the conversation, but it came out pretty quickly. I know it will sound trivial and rudimentary, but it is more important than anything else in 98% of the cases. When you are about to open any business you have to remember that you are actually running a business.
Law Firm to Restaurant to Running a Website
For the most part, it doesn’t matter what type of business you are starting…there is still the basic structure of income vs. expenses. Maximizing one while keeping the other one low is the only strategy for long term success. Granted sometimes you have to flip it a bit (i.e. leverage) for future growth, but if you don’t remember that first rule your business will fail over the long term (well, sans some creative accounting). This is true whether you are running a law firm, restaurant or a website.
Think about all those episodes of bar rescue, kitchen nightmares, etc., most of them have one thing in common they forget this “rudimentary” concept.
Going back to my colleague, will his restaurant make it? Who knows but it is certainly inspiring to listen to him talk about controlling food costs, knowing how much they have to turn over in a night to be profitable, etc.