If you have been reading this blog from time to time, I mentioned that I made an investment in natural gas by purchasing shares of Chesapeake Energy (CHK). I ended up buying these shares at $25.40 but also purchased some October 25 puts.
Well, it turns out that I didn't sell any covered calls since the account in which I hold the shares is a margin account and selling calls affects my ability to borrow against them. Unfortunately, I needed to borrow a little to manage some problems with cash flow over the past few months. (When one of your teens takes out the quarter panels of two different cars in your own driveway, you have a cash flow problem.)
However, I did manage to purchase a few additional shares today at $22.07. Since I purchased the puts for $2.45 and can sell those shares for $25, I will make a profit of $0.48 per share in a stock that dropped 10%. Isn't that great! I also purchased some January 2011 puts at the $21 strike to protect the shares that I picked up today. I am hoping that next month I can sell a few calls since I believe the cash flow issue will be improved.
As mentioned in the earlier post, I had no idea which way natural gas prices were headed. It turns out that the hurricane season has been fairly mild so far. Regardless, I did have myself hedged such that I have been able to make a slight profit rather than a loss. It sure makes it easier to sleep at night knowing that I can't lose everything.
It is possible to use the above principles for any stock trade. Simply buy a partial position in a stock and the protective puts to go along with it. Then if the stock drops significantly, you can purchase additional shares that will sell at the strike price of the put making a profit. Of course, be sure to purchase additional puts to protect those other shares in case the stock continues to fall in price. Until next time--KEEP IT REAL!