Bulletproof… FOREVER.

Hey Traders! Thousands of views, dozens of emails and 23 comments on the last post. Thank you all for your participation, whether you liked the post or took issue with it. Let’s keep up the conversation!

SO, I’ve been chronicling responses to a question I posed in one of my free webinars: “Say you have a stock that’s up. Would you like to know how to leave the upside potential open, but at the same time BULLETPROOF your stock so there’s no way you can lose any capital?”

My mailbox blew up. I’ve been responding to some folks by email, and others (with permission) I’ve been posting about.

THIS time, I’ll be sharing another ‘bulletproofing’ opportunity in which a new friend of mine stands to do very, VERY well, no matter which way his stock goes. He may even become “Bulletproof for LIFE”. I don’t know for sure if that will happen, but it certainly is a possibility.

This post is a little detailed but I’m gonna ask you to stick with it. I’ll compare the pros and cons of Steve selling now, holding without protection, or holding WITH the protection of RadioActive Trading methods. You’re gonna be ASTOUNDED at one possibility for Steve, which is bulletproof stock for life. Onward!

Let’s get some background out of the way, along with goals and a seeming conundrum for ‘Steve’. Steve owns 1600 shares of SBUX that he picked up at $12.50 a share. he wants to keep Starbucks for the long haul, seeing as how it pays a dividend and also it might represent a big hit in capital gains tax if he sells now.

Here is Steve’s catch-22: Starbucks is at an all-time high today (April 5, 2012). If he sells now, he will miss out on further upside in case the market keeps heading skyward. On the other hand this could very well be the top of the market. What to do? Sell now… take the capital gains hit (oh yeah, that)… and forever say goodbye to the potential further returns that Starbucks may generate? Or should Steve hold on and potentially lose the gains that he’s had up to this point?

Let’s use pricing from today, April 5, 2012. During intraday trading, SBUX hit as high as $58.47. By the end of the day it was at $58.18, with a cost basis of $12.50 per share, 1600 shares represents a potential liquidation profit of $73,088 right now. That is of course before capital gains taxes eat away at Steve’s profits from selling.

Remember that number: $73,088, minus taxes.

So we showed Steve how he might pick up 16 protective put options to insure his Starbucks stock, clear out ’til October at the $60 strike price for just $5.80. If Steve’s stock indeed does go up, his put options go down. But they will not erode in price as quickly as his shares of stock gain. Plus, those puts may be ‘swapped’ in the near future for other puts that will guarantee a higher and higher sale price. It’s still a bullish play to own stock along with a put.

Now, the objection that I often hear about buying puts is that it’s just plain expensive. Hm. Well, say that Steve wants to lock in the gains SBUX has had so far. But he sits on SBUX for a few days before selling and she doesn’t cooperate… the stock’s price retreats to $50 a share. Possible? Absolutely. In fact, it’s downright believable. $8.18 in missed opportunity times 1600 shares equals THIRTEEN LARGE ($13088 to be exact) down the drain. To me, THAT’s expensive.

Of course, because of his ridiculously low purchase price, Steve will still profit if SBUX retreats to $50 a share. That’s ($50 per share of SBUX) – ($12.50 cost basis) = $37.50 per share profit. Times 1600 shares, he’ll have $60,000. Not bad.

But..! If Steve picks up those sixteen October $60 put options at $5.80 apiece, a lot of the decline in the stock’s value will be cancelled if SBUX tumbles to $50. This screen from PowerOptions says that at the halfway point between today and October expiration, if SBUX is at $50, the married put position that he creates today will not be worth $60,000 in profit… but $67,536. That’s better, I’m a-thinkin’:

The red curved line shows what the married put will be worth if the stock is $50

How those put options looking now? 😉

Now for the juicy part: Steve is also able to use ‘nested spread trades’ to bring in extra premium. He might, for example, sell 16 May $60 call options at $1.22 and use some of the proceeds to buy 16 May $62.50 calls for .57 cents . That’s a bear call spread that will generate, right NOW, .65 cents per share in cash. Times 1600 shares is $1040 cash IN, right now.

Adding a Bear Call Spread brings in premium but does not limit the upside

Don’t look now, but the liquidation price at $50 a share has gone up even more.

The way I see it, Steve’s stock can only do ONE of THREE things: go up, go down, or go sideways. Look at the comparisons between selling now, staying in without protection, and using the options plays. By April 30…

SBUX at $50 (down)
Sell today, April 5 at $58.18: Profit of $73088. Tax bill next year.
Hold without protection: unrealized profit of $60000.
Hold with put protection: liquidation value of $69344

SBUX at  $58.18 (sideways)
Sell today, April 5 at $58.18: Profit of $73088. Tax bill next year.
Hold without protection: unrealized profit of $73088.
Hold with put protection: liquidation value of $72736

SBUX at $67.50 (up)
Sell today, April 5 at $58.18: Profit of $73088. Tax bill next year.
Hold without protection: unrealized profit of $88000.
Hold with put protection: liquidation value of $79088

Using the put protection, plus Income Method plays, Steve can STILL participate in the upside. If he truly knows that SBUX will certainly go to $67.50, of course he would not pick up insurance… but who can certainly say what ANY stock will do? But with the put protection you see him still getting $6,000 more than if he sold SBUX today.

Sideways movement yield looks good too: $72736 with protection versus $73088 without. The difference is almost negligible. I should point out that if the stock KEEPS moving sideways, those bear call spreads will expire worthless in May… and Steve can do it again…

But best of all, if SBUX goes DOWN… well, Steve will have the opportunity to keep the $1040 from (at least one) bear call spread, cash in the puts… and still be long a stock that pays dividends.

This one point here will really bake your noodle: Steve has said that he is a holder. That is, he will hold SBUX regardless of a market crash or bad news. His cost basis is $12.50. So what if he puts on his protection… that still allows him to participate in further upside… but instead SBUX tanks down to $40 a share? Well, think about the liquidation price of ONLY the puts at expiration. Those were October $60 puts, remember? They have to be worth $20 bucks each.

So Steve cashes in his $60 puts for the $20 apiece and continues to hold SBUX. In case you’ve forgotten, Steve’s original cost basis for shares of stock was $12.50… now that is ERASED. He’ll still have 1600 shares of SBUX, but ZERO cost basis because the puts have paid for the stock.

If ‘bulletproof’ means that your cost basis of your stock is less than the guaranteed sale price… why, Steve is now BULLETPROOF for LIFE. The value of his shares of SBUX can never fall below his cost basis, because he has no more cost basis.

Turn that one over in your brain awhile, Traders! And, let’s hear your comments below. By the way, Steve did in fact pick up put options and do the bear call spread play. Let’s check in with him around May expiry and see if he’s happy he didn’t sell SBUX.

Happy Trading,

Kurt