Shorting against the Box

Shorting against the box is another type of hedge, but one which is used for very different reasons. It is basically the shorting of an equal amount of the same stock in which you are currently maintaining a long position. It is generally used as a delaying tactic either for tax or delivery purposes. It puts your positions on hold. For example, if the long position goes up 10 points, the short position goes down 10 points.

Shorting against the Box

Karen Rigg owns 1,000 shares of Citicorp common, which she purchased at $15 per share. The stock is now at $40 per share, and her taxable gain if she were to sell the shares is $25,000. However, it is to her advantage to take these profits next year when she expects to be in a lower tax bracket. But if she tries to hold onto the shares until next year, they may go down in price. Thus, by trying to save tax dollars, she may lose three times as much through price depreciation. She, therefore, informs her broker to sell 1,000 shares "short against the box," and holds onto her short and long positions until after the first of the year. If the stock goes down in price, she gains on the short position while losing on the long. If the stock goes up in price, she gains on the long position while losing on the short. In other words, any price movement in the stock cannot affect her. She locks in her $25 per share profit less the additional commissions the short position will necessitate. However, she also prevents herself from being able to participate in any bullish surge by the stock. But that's the trade-off necessary in shorting against the box. 

Reasons for shorting against the box

There are other reasons for shorting against the box. Sometimes an investor is not in a position to deliver securities in time to her broker, and she opts for also shorting an equal number of shares in the stock in which she is long. In doing so, she locks in her profits until she returns from her European vacation and can access her safe deposit box for the shares to be delivered.

An equally good reason to sell short against the box is the one that follows.

Suppose that someone gives you shares of stock as a gift. These shares have been in their portfolio for years. And suppose that these shares are at a price four times or more above their original purchase price. If you sell the stock, the cost basis for tax purposes is the original purchase price. Thus, you decide to hang on to the stock, for the capital gains are far too much at this time meaning, for someone in your tax bracket.

Good idea! But now assume that the stock is Merck or some other pharmaceutical under tremendous downside pressure because of the Clinton Administration's policies. This puts you between the devil and the deep blue sea. If you sell the stock, the tax impact is enormous. If you keep the stock, you will lose drastically when it plummets. Either way, it seems, you will lose either to the IRS or to the market place.

What to do? You guessed it Sell short against the box until it is advantageous to take your profits or maintain only a long position in the stock.

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Share trading tips for beginners

 In this article we have briefly explained about share trading tips for beginners. The safest bet, Which share should we select for trading and the serious mistake happens during trading are explained. Gives ideas about share trading tips for beginners for earning money from stock market.

Do you have to give up your stock if the related calls go in the money? No, absolutely not. If the underlying security reaches the striking price or passes it, you may buy back your covered call and then if you wish to reduce the loss on the option, may sell another one that is out-of-the-money. The premium from the second call will offset some or all of the loss from buying back the first, while you continue to profit from the surge of the underlying stock. You may continue to buy back and write new covered calls as long as it appears to be to your advantage.

The Safest Bet

The rule remains, however, that the safest bet is in writing out-of-the-money calls. The underlying stock is less likely to be called out from under you; the value of the call will depreciate quickly as the expiration date nears (which, as a writer, you want to happen; that is, time decay is on your side); and you will almost always sell the underlying stock at a higher price if it is called.

There are advantages, also, to writing at-the-monies and in-the-monies, but the disadvantages outweigh the advantages. For instance, with in-the-monies, the stock may be called at any time, and the chances of participating in a bull market for the underlying stock are rare; and with at-the-monies, a small upward movement in the price of the underlying stock puts your position in jeopardy. Premiums are also higher for at-the-monies and in-the-monies, which means higher commissions.

Serious Mistakes in Trading

There is a serious mistake that even the pros managing trust accounts often make. This involves the selection of the underlying security for any covered call trades. Brokers like to set up discretionary covered call programs for their customers. On the surface, these are great income producers for the portfolio as well as for the broker. The broker stands to earn much more in commissions from a covered call account because he can legitimately buy and write options on the same underlying stock many times throughout the year.

Which stocks to be Selected

Less sophisticated portfolio managers will often select underlying stocks that have calls commanding typically high premiums. These are generally higher-priced stocks which the marketplace feels have great upside potential. The broker gets to write calls and to buy them back as the underlying stock approaches the striking price. Or he just lets the stock be called. His argument is that the portfolio gains in the long run because of the high income received from the call writing. But the truth is, the portfolio often does better when the call writing program is balanced so that the portfolio can not only be buffeted by call premiums but also by the underlying stock's participation in any bull market.

Covered call writing is a balancing act. The portfolio manager must always be calculating the comparative advantages of a straight call writing program against one that also squeezes additional profits from capital gains in the underlying stock. Clearly take this share trading tips for beginners for making earnings in stock market.

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The bull put spread example in Stock Market

The bull put spread example is explained in this article. Spreads are designed to take advantage of the price relationship between two or more options. Bullish speculators use primarily what are called "bull spreads" to reduce their risk. In the bull put spread example, the speculator buys and sells calls having the same (but not always) expiration date. The striking price on the calls, however, will be different. In a bull spread, the call written will always have a higher striking price than the call purchased.

Calendar Spread

  Another type of bull put spread example is that may be attractive to the bullish investor is the calendar spread, wherein the speculator buys and sells calls with different expiration The bull spread is a strategy designed for those who have a very positive outlook for the underlying stock but. want to hedge just in case. They buy and sell calls at the same time. The call bought will have a lower striking price than the call sold but have the same maturity. The easiest way to do a bull spread is to purchase an at-the-money call and sell an out-of-the-money call on the same stock. The objective is to be long on the option that will have a greater price increase if the market rises. The short position, which produces income, reduces the cost of the long position.

Dates, hoping that when she makes her closing transactions the credits to her account will exceed whatever the costs of the spread were. The buy and sell transactions required to close out the calendar spread must be made simultaneously.

There are other types of bull put spread example, but these are either combinations of bull and bear strategies or require so many positions at one time that they represent too much of a hedge to make being in the market worthwhile except when some very special price movements occur.

Arbitrage

Spreads of the above type, which are especially designed to hedge the speculator's bet, are very different from the types of spreads that speculators, such as arbi­tragers, may use as part of their aggressive speculative programs. In arbitrage, profits are realized from the spread between stock prices in different markets.

 

Arbitrage, however, is no game for the little guy. It is a game for only the highly skilled, the highly experienced, and the well-placed. By well-placed I mean that the investor is able to take advantage of immediate developments, which the average investor, listening to cable reports or occasionally checking his computer's stock quote program, cannot do.

Covered calls

 Covered calls are by nature a hedging tool. With the covered call, you are immedi­ately long on the underlying stock and short on the option.

With a covered call strategy, you can bring in extra income even when the under­lying stock is relatively stagnant. This is because once you sell the call, you receive the premium (less commissions). The premium is yours to keep. If the underlying stock never reaches the striking price before expiration time, you get to keep the stock as well as the premium.

On the other hand, if the stock is called, you get to:

•          Keep the premium.

•          Profit on the underlying stock.

But you can only be sure of profit on the underlying stock if you have written covered calls that are sufficiently out-of-the-money.

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Straddling meaning in Stock market

 straddling meaning is explained including the break even point straddles. Hedging means covering yourself in case your primary plans go afoul. Speculators and investors use hedging to protect themselves when securities move in the opposite direction from what they had hoped. In this article you will get the detailed information about straddling meaning and playing effectively in stocks using straddling.

Hedging a long position in stock with a long position in a put is called a straddle. The straddle is a valuable strategy when dealing with volatile situations; these may be stocks that are targeted for takeover, that may be affected by some political or natural catastrophe, or that stand to gain by some new product. You take positions in these stocks expecting them to soar. As the insiders will already be taking positions in these stocks, the stock prices will already have begun to move. When you jump in, then, you need a parachute for what if you guess wrong or the stock has already had its run? This is where the put comes in.

Breaking Even on a straddle

You purchase 200 shares of Golden Nugget stock, anticipating that it will be taken over by Mirage, Inc. You pay $3,000 for the stock. Fearing that the takeover may fall apart, you also purchase some low-priced far-out-of-the-money puts perhaps 10 at $.25 each (for a total of $250).

As luck would have it, the takeover does not occur (but does later on). The stock falls to $15 per share, and you lose $1,000. However, the puts increase in value to $1.25, while the stock declines in price. (Remember that each put represents 100 shares of stock.) That means their total value is now $1,250. As you only paid $250 for them, your profit is $1,000. The straddle has allowed you to break even despite the heavy loss on the stock.

Break-even point on the Straddle

The cost of the puts and of the shares of stock influence your break-even point on the straddle. This means the stock or the options have to move much more for you to make a profit than they would if you were long on only the stock or only the puts. However, it is worm the higher break-even point to reduce the downside risk.

The straddle is not a particularly good strategy on stocks that have a narrow trading range, such as utilities, which are rarely, if ever, volatile. The cost of constantly opening new positions on the options after the old positions expire will mount up and cancel out your dividends as well as, possibly, your capital gains.

On the more volatile or potentially more volatile issues, the straddle can be played for top dollars, with either long or short positions on either the stock or the puts.

For example, suppose that, in the above example, you hedged with 20 puts instead of 10. In this case, the profits from the puts would double to $2,000. Subtract from this the $1,000 you lost on the stock, and you come out ahead by $1,000. The takeover never occurred, but you still made money.

But if something can go wrong, it often will. Suppose in either instance, the stock just stayed where it was, or retreated too slightly and too close to the expiration date of the puts to affect any upward movement in the options. In this case, you might lose all the money you paid for the puts, plus commissions. You would also lose additional money on the closing stock transaction and/or commissions.

Put and Call in Straddle

There is another type of straddling meaning, and this involves two options a put and a call. In this case, you are long on the put and long on the call. The position is based on the premise that if the underlying stock moves sufficiently, the put and the call will move in opposite directions, and one or the other will assure profit.

The catch here, of course, is that often a stock does not move enough before the puts and calls expire and the straddle is ineffective. Puts and calls do not necessarily move in the opposite direction. Remember, these are decaying assets. As expiration dates approach, if the underlying stock does not make a substantial move in price, both the related puts and the calls will depreciate in value. Straddles, whether made of stock and options or just options, can only be successful under the following circumstance: The underlying stock must move substantially enough to offset any time decay in the options and allow either the put or the call to advance far enough to offset the cost of the straddle. straddling meaning is explained with the strategy to hedge safely in stock market.

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Hedge Fund definition

Hedging means covering yourself in case your primary plans go afoul. Speculators and investors use hedging to protect themselves when securities move in the opposite direction from what they had hoped. In this article you will get the detailed information about hedge fund definition in Stock market and playing effectively in stocks.

Hedging is a form of insurance in investment games. In some cases, hedges are designed simply to limit losses; but in others, they are designed to also multiply gains if an investment goes backwards. In stock and options investing, most hedges include long and short positions in stock and option combinations, or in option combinations. 

Risk Involved in Investment

Inherent risks in any type of investment make hedging a necessity. Regardless of your sophistication in stock and options investing, there are too many variables that are beyond your control, that you cannot possibly predict, and that will happen every time you have everything going for you.

Munn lists these risks as interest rate risk, market risk, inflation risk, business risk, financial risk, and liquidity risk. Interest rate risk is probably the least of these major investment concerns because interest rates are generally predictable and the astute investor keeps her wary eye on the prime rate and reacts to developments quickly. Falling rates are generally a plus for the market, and rising rates are generally a negative. Inflationary trends, too, are relatively predictable but business, finan­cial, and liquidity strength of corporations can change very, very quickly. New competition, drying markets, changes injthe executive suite, scandal, wars, even the weather can send income into a nose dive and corporate stock into the cellar. Just think of past investment disasters (unless you were a short seller): asbestos and Johns Manville, IBM and its changing marketplace, Digital Equipment and its marketing management, and Union Carbide and Bhopal.

 There are also other risks associated with hedge fund definition investing that can destroy any portfolio, no matter how solid the fundamentals of the securities it contains. These include governmental and political risk, war, defaults, and foreign exchange and expropriation risks.

 Buying Puts in Stock Market

Bullish investors sometimes like to hedge their long positions in stock with long positions in puts. Now, let's look at them from the perspective of the buyer, and then from the perspective of the hedging bull.

 

Bears buy puts because puts generally go up in value when the underlying stock goes down in price. It is a way for bears to profit very handsomely when the stock market tumbles.

In the next part, we begin looking at tools of the bull in detail. The first subject is buying stocks long, then buying calls long. Stock and options traders need to know how to hedge with puts.

  Profiting by Buying a Put

You have purchased one put on Merck stock for $300. The value of the stock when you purchased the put was $30. Before the expiration date of the contract, Merck slides to $25 per share. The put, meanwhile, has increased in value to $800. You decide to take your profits and, therefore, sell the put. Your profit is $500 ($800 - 300).

You never at any time were required to maintain any position in the underlying stock, but you profited as though you sold short 100 shares, for each put represents 100 shares of stock. How much would you have had to put up If you sold short 100 shares of stock? Given 50 percent margin, $1,500. How much did the put cost? $300.

If Stock Market goes Against You

The risks are somewhat more limited for put buyers than they are for short sellers of stock. This is because the stock can double or triple in price and losses can mount significantly. But the put buyer can only lose the amount he pays for the put plus commissions.

 But why would the bull want to buy puts when this is the bear's game?

Consider that the put usually goes up when the stock goes down (and down in price when the stock goes up). This means if you are long on the underlying stock, and the market goes against you, the put will cover part or all of your losses and possibly even let you come out a winner altogether. As puts can be expensive, generally investors hedge with very low-priced puts, hoping to make the profit on the stock., the lower-priced puts with the same expiration date and striking price are almost always the out-of-the-monies.

The best rule of thumb for buying puts is that if you are going to hedge, hedge with low-priced puts; if you are going naked, buy the higher-priced puts. As a bull, however, you will be much more interested in writing puts for additional income and in selling (writing) them as a hedge. Hedge fund definition gives you idea about hedging in the bull market.

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