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Damage Control
The Smart Profits Report: Issue #140
Friday, September 3, 2004
Damage Control: The Perfect Put Option Play for Any Season
By Karim Rahemtulla
Investment Director, Mt. Vernon Research
Hurricanes are named after people. There is no correlation between how tough the name is versus how tough the storm may be. Consider Charley - not a threatening name at all, yet it left the state of Florida with more than $12 billion in damage.
And now, potentially the mother of all hurricanes of this generation, Hurricane Frances, will be knocking on my door (hopefully not through my door) any time now. (Frances - sounds like the name of a sweet nun. I mean, at least call the storm Thor or Vlad if you really want to strike fear in the hearts of people!) Anyway, Frances is coming and I am preparing.
I am also taking an additional step to defray the possible damage control expenses that I may face from a damaging hit to my home. I figure that if I sustain damage in a solid house, located inland, then there will be a lot of others who are not as fortunate.
How I Stand to Recoup Some of That Deductible
Since Hurricane Andrew tore through South Florida a few years back, insurance companies have tacked on a large deductible to all hurricane policies issued in the state.
That deductible is anywhere from 2 to 5% of the home’s value. Still, Allstate just reported that its insurable losses from Charley will exceed $400 million… and it’s still early.
If Frances, a much larger storm, makes landfall in the Southeast, Allstate will be on the hook for more than a billion dollars in insurance reimbursements. This got me thinking.
Short-Term Put Options To The Rescue
A couple of days ago I bought put options on Allstate. It is a rare occasion when I buy a short-term option, but in this case I am going to make sure I get some of my deductible back!
This type of option trade takes place all the time. It is called hedging. The option buyer or seller, in this case me, is taking out an insurance policy to mitigate any losses from another position. It is a hedge that I hope DOES NOT work out.
I wanted to point out to you that options are a multi-faceted investment, one that can have real value when it comes to diversification. I will let you know the results of my trade next week… hopefully.
Good trading,
Karim Rahemtulla
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Today’s Smart Profits Cribsheet
- As far as I know, there are three ways to use options: hedging, speculating, generating cash flow income. I would guess that most investors associate options mostly with speculating. For more on hedging, swing over to Smart Profits #226, Hedging & Speculating: How to Enjoy Guaranteed Monthly Income With Options.
- Everybody gets the urge to speculate once in awhile. Some people do it all the time. Unfortunately, investors who fall into the category of investment speculation generally don’t last very long. Unless they are using a system… for more info check out Smart Profits #120, Investment Speculation: 6 Secrets to Creating a ‘300%-Return System’ Using Stock Options.
Related Articles:
- Option Credit Spreads: Sell First, Buy Second for 50% Better Odds
- Limit Orders: Dodging The Market Maker’s Bullet & Side Stepping The Liquidity Trap
- Stock Market Index Trading Strategy: A 2-Step Approach To A Successful Trading System
