Often times in the financial world, you will hear the term diversification.  As a financial advisor, I truly believe in that term.  I think that too much concentration in a small amount of stocks is not wise.  Most of you who know me and my style of investing know that I spend a lot of my time and energy using SPY.  It is an ETF that tracks the S&P 500.  So, whenever anyone is invested in that, you are getting 500 different stocks in your portfolio.  These 500 stocks are represented by most of the best companies in the world (my opinion of course).  Don’t get me wrong, I do plenty of other diversification as well (bonds, other stock strategies, etc.), but most of my time is focused on that underlying.

Today, I want to take it to the next level.  A lot of people are wondering what they should do if they have some money in cash that they want to invest in the stock market.  That is where today’s topic comes into play.  I want to discuss 3 basic strategies that can be used to invest in this market.  We call this “strategy diversification”.  Yes, they will all have risk, but so does everything.

1.  The first strategy is the short put option.  Let’s say you like XYZ stock and it is trading at 55/share.  You feel that you would like to buy it at 50 if it were to come down to that level.  So, you can sell the 50 put for $1 per contract (I’m totally making up all of these numbers by the way).  If the stock increases, the put will expire worthless at expiration and you get to keep the $1.  Your risk and obligation to buy the stock are done.  If the stock is below 50/share at expiration, you will be assigned and buy the stock at 50, a price you wanted to buy it at anyway.
2. “But Mike, I am worried that the stock will go higher and I don’t want to miss out on it.”  If that is your sentiment, perhaps you can consider a risk reversal.  You can sell the same 50 put option.  However, this time, you can use the $1 to buy a 60 call option.  It may not be the exact same price, but it will likely be close.  Ideally you want this to be as close to “even money” as possible.    By doing this, you will only have downside risk below 50/share.  That is a 10% cushion.  Of course the bad part of this scenario is that you will only have upside above 60/share where the call option comes into play.  However, once the stock goes high enough, you could close out the short put early and create a trade where you own the call option and it was financed by a short put you just closed.  You will not be able to close the put at 0, but you may be able to close it at a much lower price.
3. Finally, let’s say that you want to make money on the way down to 50 and still buy the stock at 50.  That is where a ratio put spread may come in handy.  You could buy one 55 put for $2/contract and sell two 50 puts for $1 per contract.  If you get these prices, it will be an even money trade.  In this example, you will break even if the stock increases or stays the same at expiration.  If it does go to 50/share at expiration, you will be assigned at 50.  However, with this strategy, you will be paid $5 to buy the stock at a level you wanted to own it at anyway.  The reason is that the 55 put will have to be worth $5 or more if the stock is at or below 50 at expiration.

I like doing something like this if you have $15,000 or so to invest in a $50 stock.  Numbers can vary with stock prices, but I’m using $15,000 as it about what you would need for this example.  You can do one of each of these strategies and have a happy outcome so long as the stock doesn’t drop significantly.  By diversifying these strategies, you put yourself in a position to win.

There are many other strategies like these that you can use in the spirit of “strategy diversification”. 

If you are interested in these or any other strategies, or you are interested in having a conversation with me as a financial advisor, feel free to reach out to me at mtosaw@stcharleswealth.com. 

Have a great day!!!