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Author: Patzer Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 1202  
Subject: Re: write covered call vs. buy put Date: 2/17/2006 7:59 PM
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I have a stock that has steadily climbed (TIE, it just split today so I have 300 sh), and I'd like to protect my profit. Should I sell a call, thereby acquiring some extra cash, or buy a put? Won't both work? What are the pros and cons?

Buying a put protects your profit up to the strike price of the put, for the period from when you buy it to when the put expires. You do this if you think the stock will keep going up, but want protection from being wrong. The worst thing that happens to you is the put expires worthless and then the stock falls. If you want permanent protection, you have to keep buying puts. This may be worthwhile for a rising stock, but it's a slow bleed for a rangebound stock. It does offer nice protection if the stock tanks.

Selling a covered call is a neutral to slightly bullish action. You sell a call if you expect the stock to go sideways or slightly upward. You expect to pocket the proceeds if the call expires worthless, or to sell your stock at an acceptable sales price if the call is in the money at expiry. The worst thing that can happen is that your stock tanks. You can't sell the stock until you buy back the call, which may take long enough for the stock to fall a lot further than when you decided to sell. The premium you collected from selling the call is not enough to make up for a major decline in the stock price. The second to worst thing that can happen is the stock takes off. You get only the strike price, having given up all the additional gain for the premium you collected when selling the call.

The easiest, and cheapest, way to protect some profit on an appreciated stock is to enter a stop-loss order. You set the order just below the lowest amount you expect normal trading fluctuations to go down to. If the stock keeps going up, you keep revising your stop-loss upwards. At some point, the stock trades down to your current stop-loss and you sell at a profit. The worst thing that can happen with this strategy is a gap down. The stock trades massively below your stop-loss, and you get whatever the market price is when this happens. The second worst thing that can happen is that the stock trades down to trigger your stop loss, then immediately trades back up. You are now out of the stock (at a profit) but leave further gains on the table. Stop loss orders work best with steadily gaining stocks. They don't work well with highly volatile stocks.

The most conservative way to protect a profit is simply to sell the stock. You get whatever gain has been achieved up to the time you sell, and forego any future gain.

The market is full of uncertainities. No strategy is without risk, so you pick the risk-managing strategy that best conforms to your view on what is likely to happen.

Patzer
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