Wealth Management Solutions
Can We Guarantee Your Investment?

 

Can we guarantee your investment? The answer is a resounding no!  And, no one else can either.  The nature of an investment is that there is no guarantee of winning or losing.  That is why they call it an investment.  However, we can design a stock portfolio for the conservative investor that preserves principal while taking advantage of stock market gains. We can set the upper and lower limits of an investment strategy, and therefore, lock in how much you can gain or lose.  By setting your downside risk at a zero loss or something very close, and setting your upside risk in double digits, we can create an investment structure that provides predictable return limits in advance.

 

The investment technique we are speaking about is called collar investing.  Collar investing is the simultaneous purchasing of a stock and a put option, along with the sale of a covered call option.  The put option protects the stock from losing value while the covered call sets and limits the stock's upside, with the premium received offsetting the premium cost for the put. This technique requires finding those combinations offering the greatest reward with the least amount of risk.  In this case, the downside market risk is reduced to approximately zero.

 

Modern Portfolio Theory has proven that over time, investing in stocks provides the greatest return and that optimally diversified portfolios reduce risk (but does not eliminate it).

 

For investors seeking portfolio protection, the equity collar can be an effective and inexpensive way to limit downside risk in the stock market.  Each position places boundaries around the stock with listed options. The protection amounts to portfolio insurance.

 

Options are contracts which allows the buyer to do or not do something in the future. Securities Options are financial contracts that convey the right, but not the obligation, to engage in a future transaction. For example, purchasing  a call option allows the buyer the right to buy a specified amount of a security at a set price at some time in the future on or before the options’s expiration., while buying a put option provides the right to sell. Conversly, selling a call or a put provides the opposite. If at any time the  option position benefits the holder they may choose to exercise the option or let it expire worthless.

 

While many people are familiar with options that are three, six and nine months in length, the stocks in these positions may be wrapped in the collar for a period as long as one or two years.  While the stock is wrapped in the collar, any gain or loss is limited to the minimum and maximum price range of the collar no matter how much the stock actually rises or falls.

 

For example:

 

Equity Collar for XYZ Stock

 

Buy a Put Option that will expire 1/17/09 @ $520.00

Sell a Call Option That Will Expire at 1/17/09 @          $590.00

 

Purchase stock 9/18/07 (Ask Price)     $526.00   

                                               

Buy Put (Ask Price)                  $56     

Sell Call (Bid Price)                 -$56

 

Net Collar Cost                        $0

 

Less dividends assumed for 487 days    $0

Stock Break Even on 1/17/09               $526.00

 

Upside per-share if sold at $590                        $64

Risk per Share If Sold at $520                          $6

 

Percent Gain for 487 Days.                               12%

Percent Loss for 487 Days.                               -1%

 

Percent Annualized Gain:                                   9.1%

Percent Annualized Loss:                                   -1%

Risk Reward Ratio:                                         11 to 1

 

*The above data is hypothetical.  This example is merely to illustrate some of the mechanics involved in establishing an equity collar.  In this illustration there are no dividends, or transaction fees illustrated.  This example, and any information derived from this example should not be used as a primary basis for any investment decisions, nor does it constitute tax, legal or accounting advice and is not an offer to buy or sell any securities or securities instruments.  This type of investment may not be suitable for all individuals and is purely for educational purposes only.

 

 

For investors seeking portfolio protection but still want the ability to have the upside potential of stocks, we can construct a portfolio of stocks protected with equity collars. Our target upside is (but not always) 10% to 25% and our lower boundary is between 0% and -5%, depending on the risk tolerance of the investor.

 

This type of collar protected portfolio investment is suitable for:

 

·        Middle income investors - it enables them to take a greater upside risk.

 

·        Wealthy investors - looking for higher returns while protecting their principal.

 

·        Individuals who buy guaranteed annuities, equity linked CDs and other structured notes.

 

·        Nontaxable accounts such as IRAs, retirement plans, and as a bond alternative.

 

You insure your homes, your cars and your life, why not your stock portfolio?

 

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