Insure your shares for downside protection
This is what makes Planet Wealth stand out from the rest. Over the coming months, we will be showing you the Six Simple Systems that Planet Wealth use to make consistant profits in the share market.But first, lets get back to our current example and learn about how to buy insurance against a stock market crash.
As all traders know, Capital Protection is rule number 1 on any portfolio. So if this is the case, why have so many people lost massive amounts of money over the last 12 to 18 months? The doom and gloom of the current economic crisis should be an indicator that we need to protect our assets. You wouldn’t own an investment property and not insure it against damage or loss of rent, would you? So why would you invest thousands of dollars in the stockmarket with the risk of losing it all. Perhaps it’s because a lot of people simply don’t know that this strategy is available. So, assuming this is the case for some people, I will attempt to explain the how and why.
Whenever we buy stock in our Renting Stocks portfolio, the first thing we do is buy insurance to protect the stock in case of a big fall in price. However, we can live with a small loss and therefore don’t need to insure the full cost of our shares. This will obviously incur a charge, but it is taken from the premium we received from renting out our shares. That way, will still make a profit, but just not as much. At least we have insurance though right?
It is only necessary to insure against a really big drop in price, therefore we only buy insurance a few dollars below the current stock price (which protects the bulk of our money, but not all of it).
Let’s use an example to help me explain:
Company XYZ is trading at $19.97. We bought 200 stocks and would therefore buy insurance at $15 to protect most of our capital. Our rental premium was $240 for our 200 stocks and lets say it cost us $72 to insure our stocks at $15. This means that after we receive our rental ($240) and buy our insurance ($72) we end up with $168 of income.
Now that we have insurance, we have a guarantee we can sell our stock at $15 – regardless of its current price – at any time before the rental period expires.
Let’s look at the worst case scenario: Something happened to XYZ and the share price dropped considerably, let’s say all the way down to $5.
If we didn’t have insurance, we would be looking at a loss of $14.97 per stock, or $2,994 for the trade. That’s a big chunk of our initial investment, which was $3,994.
Imagine if the absolute worse case scenario happened – the company went broke – making the stock price zero. That would mean we’ve lost ALL of our investment! That’s nothing short of a disaster. But here’s the good news…
Because we have insurance, we have a guarantee we can sell the stock at our insurance price of $15 (even if the company goes broke).
That means we have only lost $4.97 per stock, or $994.
That’s the most we can ever lose, even if the stock went to zero.
So, for the sake of sacrificing a little bit of profit, we are guarenteed protection against any type of loss. We bought the stock for $19.97 and if the price ever falls below the $15, we can claim it back and be guaranteed to sell them at $15. Now to me, that makes a lot of sense. We must be in this for the long term and sacrificing some of the profit just to stay in the game, really makes a lot of sense. We are not here to get rich quick. We are here to replace our income and provide consistant profits, month after month.
Until next time, happy trading.
