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Re-Ownership Strategies Explained: Have your Cake and Eat It Too

January 30, 2012 by John Payne| Tips & Strategies

Part 1: Hedging Stock Exposure

For those of us who are involved in the buying and selling of assets, the feeling of buyers/sellers remorse is one that can remain with us for a while. As anyone who has participated in these markets can attest, it is almost impossible to sell at the very top and buy at the exact bottom. The feeling of remorse is not only frustrating, but it can lead to emotional swings that may cause a trader to veer off plan and make mistakes. Thankfully, there are things hedgers and speculators alike can do to help eliminate that remorse.

We’ve discussed the ratio spread in a previous article. For those who are new to this strategy, it involves the simultaneous purchase of one option along with the sale of two options. This spread can be done many ways, but for the examples explained in this article, we will be buying one call close to the money while selling two calls further out of the money. Let’s jump into a real time example. For this blog, we will examine this strategy and discuss how a stock investor can use a re-ownership ratio spread strategy to “have his cake and eat it too”.

Please click to view the Spreads and Options risk disclosure below.

Jim is a buy and hold stock investor. He has a stock portfolio of approximately $130,000 that is highly correlated with the S&P 500. Jim realized over his life that timing the purchases and sales of the stocks in his portfolio has been difficult. Jim suffered through the stock market drawdown in 2008, and he hasn’t sold anything during the last 3 years. He has been faithful to this buy and hold formula. However, as his retirement age approaches, he realizes that he might need to scale back the holdings in his portfolio as the markets have been friendly to him lately. Because of these feelings and his ability to do basic chart analysis, he feels that the S&P will be getting “toppy” around the 1340 levels. He wishes to cut his stock investments by approximately 50% around these levels. (50% of his stock account is $65,000, which is very close to the value of 1 E-mini S&P futures contract, 1310 x $50 per point= $65,500).

Because of his lack of fortune when it comes to timing, Jim dedicated himself to learn about re-ownership strategies. He had never traded futures or options before but knew of the leverage the futures markets provided to make this strategy work. He understands that this strategy is a dual market strategy. He will be making “cash” sales in his stock account while entering a ratio spread in his futures account. Jim provided his Daniels broker with his understanding of the strategy and his demands for upfront cost – his broker took care of the rest.

Please click to view the Leverage risk disclosure below.

The trade will be executed like this:

Jim will sell 50% of his stock portfolio when the S&P 500 hits 1310. Simultaneously, he will buy a 1310 June E-mini S&P 500 call for 60 points($3000) and will sell 2 June E-mini S&P 500 1380 calls for 30 points each ($3000). Because he is long the 1310 call, upon expiration in four months, Jim will make $50 dollars for every point the S&P 500 is over 1310. He will cease making money if the market would expire anywhere over 1380.

If this were a normal ratio spread without any cash stock behind the trade, Jim would begin to take losses as the S&P continued higher over 1380. In this case, his futures account will take losses for every point the E-mini expires over 1380, but those losses will be offset because he owns the equal (or greater) amount of stock. If the market rallies to 1450, he will not profit as the market runs higher from 1380-1450. If the market would sell off and expire in 4 months anywhere under 1310, his ratio spread will expire worthless with a net loss of zero before fees because he bought the 1310 call and sold the two 1380 calls for equal amounts. If the stock market would take a turn for the worse and sell off a substantial amount, Jim would not be taking the losses he would have before because he has already sold a portion of his stocks.

We call this a re-ownership strategy because Jim sold stocks in his cash account and “re-owned” the stock index on the board using options. When doing a strategy such as this, it is very important to understand what will happen to both accounts wherever the S&P 500 would be in June of 2012.

For more questions on this type of strategy and how you can use it to help protect your investments, contact a Daniels Trading broker at 800.800.3840

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Filed Under: Tips & Strategies

About John Payne

John Payne is a Senior Futures & Options Broker and Market Strategist with Daniels Trading. He is the publisher of the grain focused newsletter called This Week in Grain, along with being a co-editor of Andy Daniels’s newsletter, Grain Analyst. He has been working as a series 3 registered broker since 2008.

John graduated from the University of Iowa with a degree in economics. After school, John embarked on a 4 year career with the United States Navy. It was during two tours in Iraq and the Persian Gulf where John realized how important commodities are to the survival of society as we know it. It was this understanding that brought about John’s curiosity in commodities. Upon his honorable discharge in 2007, John’s intense interest in the world of commodities inspired him to move to Chicago and pursue his passion in a career in the futures arena.

After a three year position with a managed futures firm specialized in livestock trading, he was given the opportunity to join the team at Daniels Trading. Being in the business and seeing how other IB’s operated, it was the integrity and straightforward approach of the Daniels management team and brokers that attracted him to make the move. Since joining Daniels, John has broadened his fundamental and technical analysis of the markets even further. John has been writing his newsletter This Week in Grain under the Daniels banner since 2011.

Working in high pressure industries like the military and capital markets, John has learned the value of preparation in times of stress. He believes that instilling within his clients the value of a good plan and a cool head for dealing with the day to day swings of commodity markets. He treats every client as a teammate, understanding that his job is to help clients achieve their goals, whatever they may be.

John is a proud supporter of the Iraq and Afghanistan Veterans of America, the Veterans of Foreign Wars and the National Corn Growers Association. When he is not working, he enjoys athletics of all kinds and spending time with his wife and their two kids.

John’s commentary is featured in the following publications:

* All Ag Radio – Sirius Channel 80
* AM 880 KRVN – Lexington, Nebraska
* RFD TV
* Wall Street Journal
* Barron’s
* China News Daily (English version)

Risk Disclosure

WHEN INVESTING IN THE PURCHASING OF OPTIONS, YOU MAY LOSE ALL OF THE MONEY YOU INVESTED.

WHEN SELLING OPTIONS, YOU MAY LOSE MORE THAN THE FUNDS YOU INVESTED.

THE RISK OF LOSS IN TRADING COMMODITY FUTURES AND OPTIONS CONTRACTS CAN BE SUBSTANTIAL. THERE IS A HIGH DEGREE OF LEVERAGE IN FUTURES TRADING BECAUSE OF SMALL MARGIN REQUIREMENTS. THIS LEVERAGE CAN WORK AGAINST YOU AS WELL AS FOR YOU AND CAN LEAD TO LARGE LOSSES AS WELL AS LARGE GAINS.

STRATEGIES USING COMBINATIONS OF POSITIONS, SUCH AS SPREAD AND STRADDLE POSITIONS MAY BE AS RISKY AS TAKING A SIMPLE LONG OR SHORT POSITION.

This material is conveyed as a solicitation for entering into a derivatives transaction.

This material has been prepared by a Daniels Trading broker who provides research market commentary and trade recommendations as part of his or her solicitation for accounts and solicitation for trades; however, Daniels Trading does not maintain a research department as defined in CFTC Rule 1.71. Daniels Trading, its principals, brokers and employees may trade in derivatives for their own accounts or for the accounts of others. Due to various factors (such as risk tolerance, margin requirements, trading objectives, short term vs. long term strategies, technical vs. fundamental market analysis, and other factors) such trading may result in the initiation or liquidation of positions that are different from or contrary to the opinions and recommendations contained therein.

Past performance is not necessarily indicative of future performance. The risk of loss in trading futures contracts or commodity options can be substantial, and therefore investors should understand the risks involved in taking leveraged positions and must assume responsibility for the risks associated with such investments and for their results.

Trade recommendations and profit/loss calculations may not include commissions and fees. Please consult your broker for details based on your trading arrangement and commission setup.

You should carefully consider whether such trading is suitable for you in light of your circumstances and financial resources. You should read the "risk disclosure" webpage accessed at www.DanielsTrading.com at the bottom of the homepage. Daniels Trading is not affiliated with nor does it endorse any third-party trading system, newsletter or other similar service. Daniels Trading does not guarantee or verify any performance claims made by such systems or service.

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Risk Disclosure

This material is conveyed as a solicitation for entering into a derivatives transaction.

This material has been prepared by a Daniels Trading broker who provides research market commentary and trade recommendations as part of his or her solicitation for accounts and solicitation for trades; however, Daniels Trading does not maintain a research department as defined in CFTC Rule 1.71. Daniels Trading, its principals, brokers and employees may trade in derivatives for their own accounts or for the accounts of others. Due to various factors (such as risk tolerance, margin requirements, trading objectives, short term vs. long term strategies, technical vs. fundamental market analysis, and other factors) such trading may result in the initiation or liquidation of positions that are different from or contrary to the opinions and recommendations contained therein.

Past performance is not necessarily indicative of future performance. The risk of loss in trading futures contracts or commodity options can be substantial, and therefore investors should understand the risks involved in taking leveraged positions and must assume responsibility for the risks associated with such investments and for their results.

Trade recommendations and profit/loss calculations may not include commissions and fees. Please consult your broker for details based on your trading arrangement and commission setup.

You should carefully consider whether such trading is suitable for you in light of your circumstances and financial resources. You should read the "risk disclosure" webpage accessed at www.DanielsTrading.com at the bottom of the homepage. Daniels Trading is not affiliated with nor does it endorse any third-party trading system, newsletter or other similar service. Daniels Trading does not guarantee or verify any performance claims made by such systems or service.

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