Case Study for Put Options
I have been following Green Mountain Coffee Roasters (GMCR) as a company and a stock for about a year now. I have not invested in the stock but became interested when I bought my third Keurig coffee maker. My wife had gotten one since she occasionally drinks coffee but is the only one in our house that does so. She also used it for heating water and brewing ice tea. Of course, it comes in very handy when company is over, and you want to brew a single cup of coffee as well. The kids will use it for hot water to make hot chocolate.
Since my dad enjoys his coffee, I got him one for Father’s Day last year. Finally, so my wife wouldn’t lose hers, my daughter received one to take with her to college this fall. She doesn’t drink coffee but used it for water to brew iced tea as well. After this third purchase, I thought about Peter Lynch and decided to figure out who made these things. And so began my tracking of GMCR stock. Needless to say, I wish I had bought some last fall, but I didn’t. The price action does, however, make a good case study for the use of protective puts.
Had I bought the stock in the fall, I could have purchased it for under $30 per share. As someone who believes in owning puts on every stock I own, I would have purchased puts with a $25 strike price limiting my loss to about 10% of invested capital. I probably would have paid for about 3 or 4 months worth of protection meaning that I could have owned the stock from October through January with a well defined risk. When it traded above $35 per share in December, I would probably have locked in a profit by rolling up those puts to the $35 strike and selling the others for whatever I could get.
If I had wanted to continue owning the stock, I could have rolled out those puts as well giving myself a longer time frame before having to purchase additional puts. If you look at the chart for GMCR, you will notice that the stock takes a large gap up in March and early May such that it is now trading over $79 per share. Once the gap occurs, you can buy additional puts to protect the profit that happens with the gap. Granted you will give up some of the profit by paying for the puts, but you wouldn’t have to sell the stock right away concerned about trying to find a top. To get around the cost of the puts, I will often sell covered calls on some of the shares or sell 100 shares at a profit to pay for the put options which protect the rest.
How do I know that this is the way I would trade the stock? Look at the charts for ONXX, SLW, and AKAM. These are 3 of the stocks in my portfolio that I am trading currently. I purchased AKAM in the 20’s and rode it up to 50 last fall. Now I am back in and selling calls while waiting for it to consolidate and rebound. I have owned ONXX for a while now and gradually increased my position on the way down. Now I am selling on the way up and have $42 puts for June. Profit is guaranteed! You get to follow my SLW trades step-by-step. Although I am currently down, this is not the first time I have owned SLW. I first started buying it in the teens and have cashed out a couple times already. I will update the latest on SLW later in the week.
I hope that you are getting a feel for the flexibility that can be obtained through options. I own puts on everything to protect capital but sometimes sell calls against all my stocks to pay for the puts and sometimes I allow shares to be uncommitted in order to participate in a rally. I may not make the most gains, but I don’t lose much either. Plus, I am still learning and getting better at picking stocks and managing the options.
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