Investors ideas

[Jampone]

Hi guys,

This is my first blog entry and I want to share something I have learned in the past few months and I think it´s a really good Idea for those who are investors.

To start with, I need to introduce myself.
I am from Brazil and have been trading since january 2009, I also took the price action pro course. At the moment I cannot trade the brazilian market because I am working for a broker in the futures sector (Deutsche Bank). During this month I am working there I noticed that big instituions don´t really work with a lot of Risk. I noticed that the bank is almost always doing some kind of hedge to reduce the risk of the trades they place. Now I am going to mention some simple ideas for those who like holding long positions for minimum 6 months.



let´s suppose you bought 1000 shares of Rimm and you don´t want to sell it for the next year. you bought the shares when price broke above 50,00 with a stop below 48. At the moment price are at about 57,50 and approuching a previous low (resistence) and when you look at NASDAQ index and it´s also approching some resistence, you can do the following:

1- doing hedge selling futures contracts.
When you sell futures contracts and the index goes down, the price of the stock is also likely to go down. If it does go down, you are going to lose the value of the stock but you´re going to earn the short position in the futures contract. if the index breaks the resistence and goes up, you stop with a loser in the index futures but you win with the price of the stock, that is likely to go up as the index goes.
Result: you´re not going to lose the amount of you profit doing this kind of hedge.

2- selling options with a strike a little above the current price.
Let´s use the same example, you expect the market to correct in the next few days and you have 1000 shares of RIMM, you bought when prices broke above 50 with a stop below 48. Current price is 57.50. to protect your profit you sell 1000 call options of RIMM with a strike price at 58. If the market goes down, you´re going to lose with the value of the stock but you´re going to earn with the options you sold. As the strike is above the current price, the options´owner is not going to execute his options and buy the shares for 58, so all the money belongs to you. if the market goes up and the stock price stays at 59, the options´owner is going to execute and buy your shares for 58, so you´re going to win more 50 cents in the trade.

Well I hope you understood what I meant.
Any comments let me know!

[Brendan Egan]

Hey Joao,
Sorry for not replying to this sooner! I took a few days off and didn't even notice your post until now!

I am looking forward to seeing some more of your ideas as this certainly is a new direction that most traders don't look too closely at, at least on 123LearnToTrade.

I personally don't have many longer term positions and usually don't worry about any sort of hedging with futures/options on swing trades so I don't have a ton of experience when it comes to hedging with various financial instruments. Usually when I place a trade I like to rely on my analysis and try not to worry about hedging the trade, etc. and making things more complex than they need to be aside from a simple entry, stop loss, and profit target.

I do think that there are a lot of traders out there, however, and especially longer term traders who do hedge their trades and using the futures and options markets are two very popular ways to do this.

I'm looking forward to more of your posts on this topic as again it is something that I never looked too deep into.