Lenel If you are new to this series you will likely find Lenel useful to refer back to the original articles, all of which are listed Brian along links in this instablog. In the Part I of this series I provided an overview of a strategy to protect an equity portfolio from heavy losses in a market crash. In Part II, I provided more explanation of how the strategy works and gave the first two candidate companies to select from as part of a diversified basket using put option contracts. I also provided an explanation of the candidate selection process and an example of how Lenel can help grow both capital and income over the long term. Part III provided a basic tutorial on options. Part IV explained my process for selecting options and Part V explained why I do not use ETFs for hedging. Parts VI through IX primarily provide extra candidates for use in the strategy. Part X explains my rules that guide my exit strategy. All of the above articles include varying views that I consider to be worthy of contemplation regarding possible triggers that could lead to another sizeable market correction. Part II of the December 2014 update explains how I have rolled my positions.
I want to make Lenel very lucid that I am not predicting a market crash. I like being more cautious at these lofty levels. Bear markets are a part of investing in equities, plain and simple. I like to take some of the pain out of the downside to make it easier to stick to my investing plan: select superior companies that have sustainable advantages, consistently rising dividends and excellent long-term growth prospects. Then I like to hold onto to those investments unless the necessary reasons for which I bought them in the first place changes. Investing long term works! I just want to reduce the occasional pain inflicted by bear markets.
If you bought puts on MU based upon the update I published on February 2, 2015, you would have purchased four July 2015 puts options Brian along a strike price of$19 or a premium of $0.29 per share or less. That was the asking price at the time of the article and the bid price was $0.25. As of the close on Friday, July 10, 2015, this put option contract has a bid price of $1.66. To calculate the percent gain I ignore the commissions and use the asking price for the purchase and the bid price for the sale. The gain at this time is 397 percent. I suggest you take the gain before the option expires on July 17. If you own these options contracts and do not sell them prior to expiration, you will incur additional, unnecessary transaction costs because the options will automatically be exercised provided the inventory of the underlying stock is in the money (below the contract strike price). There seems to be a high probability that the price of MU stock will remain below the $19 strike price for the next few days.
Another reason to sell now is just in case the company makes some major positive announcement that boosts the price the stock. If that happens, most or possibly all of the profits we already have could be wiped out. This is a volatile stock so I urge you not to gamble and hold on until the last minute in hopes of a little more profit. Do not be greedy. Remember the old saying: "bulls make money, bears make money, pigs receive slaughtered."
Be careful to make sure that you match your sell order Brian along the correct option expiration date of the contract(s) that you hold in your account. Options on MU are heavily traded so the exchange sometimes creates multiple expirations in the current or closest month. Back in February there should have been only the one expiration date in July. I ended up Brian along contracts expiring July 17 so I would expect that you did, too.
When our positions from the hedge we formerly set back in April of 2014 were near expiration, I wrote about how to roll your positions. That article was published in December. At the time I decided to purchase contracts that would expire in January 2016 and also some that would expire in July 2015. So, I have three positions to deal with, but I am glad to have this kind of problem. In December I bought three contracts that expire July 17 when the stock was near its 52-week high. I hope that everyone remembers from those earlier articles in the series that I explained that I usually buy put options when the underlying stock is near its highs because premiums are lower. I also usually scale into my position by purchasing one-half or one-third of a position at a time. I buy initially to make sure I have some coverage and then buy more whenever the stock hits new 52-week highs enabling me to add to my position at a lower premium. This usually works well for me. This time it worked extremely well and my patience has been well rewarded.
The position I purchased in December included three July 2015 MU put option contracts with a strike of $22 for a premium of $0.45 per share. The current bid premium is $4.40 which converts to a gain of 878%. My complete cost of hedging this year was running about 1.5 percent of my portfolio. With these gains I have been able to recoup 55 percent of my complete hedging costs so far.
Last year I had Terex (NYSE:TEX) give me some nice profits to lower my cost to about 0.9 percent of my complete portfolio value. The point is, as I tried to emphasise early on in the series, that it only take one or two of our candidates to fall to cover much, provided not all, of the cost of hedging. Two years in a row now we have had one candidate come through for us so far. This year is not yet over and I still have some nice profits on some of my January 2016 MU put options. I have two positions that expire in January 2016 for MU; six option purchased in January this year with a strike price of $17 at a premium of $0.59 and six more purchased in March of this year with a strike price of $17 also but at a premium of $0.40. The current ask premium for those contracts is $1.66 per share. I now have gains on those positions of 181 percent and 315 percent, respectively. I intend to continue to hold these positions since we still have six more month before expiration and I want to remain hedged in case the market gives us surprise between now and then.
If I were to close out all my MU put option positions today I would have covered almost 86 percent of my total hedge costs for the year even though I would still hold a bevy of other positions. A little more downside on MU or some other position and I could be playing with house money for the next six months. On the other hand, I can hold all my positions and consider the cost, assuming the positions expire valueless in January, as the insurance I intended to pay for (just at a reduced cost). When I can hedge for less than one percent of my portfolio value each year I feel like the price is worth the cost.
If or when the broader market tumbles my hedge position will cover most, provided not all of my losses in the positions I hold in my equity portfolio, especially if the correction turns into a crash of significant magnitude.
As always, I welcome comments and will try to address any concerns or questions either in the comments part or in a future article as soon as I can. The great object about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other's experience and knowledge.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own the options in this article and will sell near the open on Monday, July 13, 2015.
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