The average person insures their car, house, health, travel and income. However, I only know a handful of individuals that insure their shares. With the volatile nature of the share market, it seems suicidal to ignore this strategy.
I imagine that sleeping at night would be significantly more peaceful if your investments were protected. The main reason there is an absence of this powerful type of insurance is ignorance. The majority of hobby investors don't know it exists.
So let me paint a picture for you. You buy a 1000 shares in company XYZ (the minimum amount required for insurance in the Australian market or 100 in the US ($2000)) at $20 a share. You insure that share for 12 months with a $20 (At The Money) put option. XYZ goes bankrupt and the stock is worthless. Guess what? You are guaranteed to sell those shares back to the market for $20.
In uncertain economic times, a put option provides peace of mind knowing there's the secured ability to sell your shares at the same price you initially paid for them.
Shares can either go up, sideways or down. If the price goes up you make a profit, which by the way has unlimited upside potential. (You never know which company might be the next Berkshire Hathaway!) If the price goes sideways it doesn't matter you'll probably break even. Should the share price fall, again you can still break even. Sound promising?
But what about the cost of insurance? Well generally speaking you're looking at around 8-10% of the share price. However, you can often cover the cost of your insurance if the company pays dividends. For example, if you received $1 dividend per share (for company XYZ) it would cover a significant portion of your insurance premium.
Alternatively, you could write a current month 'covered call' (one strike Out Of The Money) consistently throughout the 12 month period (or every month if you're a capitalist).
A 'covered call' is when someone pays you a premium ( which is normally around 3-5% of the share value depending on the duration and price of the contract) for the right to buy your shares at a certain strike price e.g. $22.50 for the $20 XYZ shares. This is also referred to as 'share renting'.
If the price of the share goes to $22.50 or above by the end of that month, your 'tenant' will most likely exercise the right to buy your shares. That's good news for you because you made a capital gain. You can then sell your insurance back to the market (it will be worth less now due to time decay) and buy the shares back again insuring them with a $22.50 put option or simply keep the profit.
Some lending facilities will lend you up 100% of the share value if they are fully insured at the price you paid for them (known as At The Money). I believe JB Global is one such company.
In this instance you only have to pay the insurance premium (8-10%+) and the 9-10% interest on the borrowed money. So it would cost somewhere in the vicinity of $3000-$4000 to buy $20,000 worth of shares in XYZ whilst having full downside protection.
This strategy allows you to focus your investments, lower your risk and potentially realise larger gains. One of my advisors suggests spreading this strategy over 3-5 companies and no more.
I'm not a licensed financial advisor, so this article is general advice only and based solely on my own personal investing experience. You must consult a professional before you execute any of the respective financial strategies. Talk to your accountant or stock broker and get them to see if this strategy suits your financial needs.
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