“Millionaire’s Crash Insurance: The Ultimate Safety Net”

By Travis Johnson, Stock Gumshoe, February 25, 2008

We can’t help it, can we? When the market goes up, we look for 800% returns on microcap rockets, when the market goes down, we panic and wonder how we can be like those Wall Street fat cats who seem to do well no matter where the market moves.

(The answer to that second one, of course, is to charge fees to your customers regardless of market direction, and get enormous bonus checks even when your firm loses money … but I digress.)

The ad I’m getting questions about now is for “Crash Insurance,” which of course is exactly what we all wish we had before October 1987 … or before the Nasdaq bubble bursting. Or even last October when the S&P was well over 1500 (we’re down about 10% from there at the moment).

So do you want crash insurance? Do you need it? That’s a question only you and your financial adviser can answer … but I can at least tell you a little bit about it.

This is, actually, the same exact teaser that started circulating at the beginning of the year … just with a little extra info, and that new “crash insurance” name. Last time I saw this it was just called the “Paddle Strategy,” a name that was a little easier on the heart valves than “crash insurance.”

From the ad:

Insurance is “a simple hedge against catastrophe. But what if you could get the same kind of protection against a catastrophe in the stock market?”

“… some of the richest investors in Wall Street history have done exactly that. Not only to protect themselves against collapse, but to pile up fortunes as the rest of the market falls apart … It can cost them as little as $2 per share. Sometimes even less.”

“Yet not only can it balance out a “bust” in the stocks they hold… it can actually pay them back three, four, even five times their original position. The bigger the bust, the more they make. How is that possible?”

Of course, if you’ve watched the stock market for any length of time you know that anything is possible — the only question is, how much does it cost?

And the “$2 a share” bit is, of course, completely worthless — except in that it makes this seem like a good, cheap thing that individuals could access. $2 per share of what? How much does the share actually cost?

So what are we talking about here? Well, I’ve actually looked at this ad before and was unable to be definitive … but now that I’ve seen this new one with the “$2 a share” detail added to the tease, I can be a bit more certain that we’re just dealing with plain ‘ol put buying.

That was one of the three “bear market” strategies I considered when writing about the first email I got in this “Paddle Strategy” ad campaign.

The only real bear market “insurance” that you could easily pick up for a couple dollars a share is a put option.

For those who don’t want to go back and read my whole exhaustive Paddle Strategy post, or who still remember it, a put option is essentially just a bet that a particular stock (or ETF) will go down to or below a particular price by a specific date. Almost anyone can get permission to trade options in their brokerage account, though most individual investors tend to lose money with options strategies if the experts are to be believed (it’s very easy to lose money, so I believe them).

Quick illustration with made up facts:

I own shares of Google with a cost basis of $500. I am convinced that this will be a long term winner and I’m wiling to hold through some tough times. But it makes up 25% of my portfolio, so I’m a little bit panicked about what would happen if the Justice department suddently decided to shut down their ad program for monopolistic practices and my investment became nearly worthless overnight.

So I buy some puts. I own 100 shares of Google that cost me $50,000 and I want to protect much of that capital. I decide that I want to be protected if the stock falls by maybe 20-30% or more, but I can take a smaller loss. So I buy a September 2008 Put option at $450. That means that I retain the right to sell 100 shares of GOOG for $450 a share until the expiration date in September, and in exchange for that right I’m paying roughly $30 a share at the current quote. So, this “insurance” would cost me roughly $3,000.

If GOOG goes to $420 or below by September, I’ll make money on the put that will offset my loss in the shares. If it stays above $450, I’ll likely lose the entire $3,000.

That would be a protective put, which is in spirit more like the idea of “crash insurance,” hedging your bets to make sure you don’t lose too much. What I’d call a speculative put would be if you bought that put without owning the underlying shares — the facts of the transaction are the same and you still can’t lose more than $3,000, but in practice this is a bet against the stock, not just “insurance” or protection in the event that your stock declines and impacts your portfolio.

And as always with options, keep in mind that time is everything — the reason that so many options expire worthless is that they have firm expiration dates — you can’t just bet that a stock will decline, but you have to bet it will decline by a certain point. And if you want more time, you have to pay more (that same $450 put option on Google shares with a January 2009 expiration, for example, would cost another $11 a share for that extra three months).

You can win big if you bet right, just like any kind of gambling, and the tougher the odds the bigger the possible win (or the bigger chance of losing everything) — which is why options trading heats up sometimes as a likely indicator of folks trading on insider knowledge before a news release or merger. If you could accurately predict the short term dramatic movement of a stock that, for example, announces they’re being acquired for an 80% premium, you could retire on one trade if you bet enough. Or at least get the SEC’s attention.

Personally, I’ll take out a put option now and then, but 99% of the time it’s just to protect my existing positions because I’ve shown no particular talent for predicting when share prices will fall, even of crazily overvalued companies. If I have a few companies that are outsize portions of my portfolio, for example, I might buy some put option contracts against those shares to make sure I don’t get hit too badly if one of them gets cropped catastrophically by some unseen future problem (which in my book means down 30-50%).

The nice thing about puts is that you can easily define the amount you’re willing to lose (you can’t lose more than you spend to buy the put contract, since it’s an option and not an obligation — unlike traditional “shorting” which obligates you to repurchase your borrowed and sold shares at some point and can make you lose much more than your initial investment).

So, that’s what “Crash Insurance” means in the stock market — and the fear of that crash is apparently what’s being sold by the publishers of the Strategic Short Report, which will purport to tell you which short bets to make in this strategy, and when. Whether it will work for you or not I can’t say, but I can tell you that it will cost you $750 at the current sale price …

… the Gumshoe’s wisdom remains, of course, free. As long as you can tolerate ads and occasional pleas for contributions.

OK, who’s the smarty pants in the back who said, “you get what you pay for?”

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7 Comments on "“Millionaire’s Crash Insurance: The Ultimate Safety Net”"

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Dividends4Life
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February 25, 2008 8:20 pm

Which do you think is easier to sell fear or greed? In a down market it would have to be fear and it would be greed in a bull market. Considering the two extremes, I wonder which of those two are the easiest? I would guess greed in a bull market.

Best Wishes,
D4L

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February 26, 2008 10:23 am

D4L, I think it depends more on the person than on the market — behavioral economists have noted that the young and inexperienced are much more likely to feel fearful in the stock market, the older are more likely to be greedy. Kind of sounds odd, but I guess it makes sense. In general, my impression from watching these ads over the years is that when you’re trying to sell an investing idea, greed must work dramatically better than fear, just because it’s the basis of the vast majority of the ads.

Thanks for the comment.

Jackie
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Jackie
February 26, 2008 11:07 am

Would selling the calls have the same effect and give you more money?

Thanks for the opportunity.

Jackie

G IMBURG
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G IMBURG
February 26, 2008 11:47 am

A note for Jackie.Yes, however, you may not make as much money if the stock goes south because owning a put trades on premium whereas your sale of calls limits your gain to one price received.

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February 26, 2008 11:48 am
If you mean selling calls against your owned stock, that’s more of an effective “smoothing” exercise that gives you some income than it is real downside protection, which isn’t to say that it’s not also an effective strategy for some people. Selling calls provides income and reduces your cost basis a bit, but doesn’t protect you very much from significant declines, or let you profit from declines. You only get the money you receive from selling the call, so if you sold a GOOG $600 call for September of this year for $10 that really only gets you $10 per… Read more »
ja
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February 28, 2008 6:42 pm

I did subscribe and they had all wins about 5-6 in 6 weeks but the wins were small. Are they still good?

ja
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February 28, 2008 6:43 pm

I am talking about marketfn.com

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