When you buy insurance for your vehicle, it responds by a large percentage of the initial purchase price in case of a disaster. When you buy insurance for their shares, that reimburses a large percentage of their investment in the case of a financial disaster, plain and simple!. How to buy insurance at this very moment I’m writing this article, the price of the shares of General Electric Co. (GE) is trading at $ 12.46/accion. Suppose you buy 100 shares of GE at the same price (total cost $ 1,246 without fees). In this example, your maximum risk is losing the total investment equivalent to $ 1246. This is the classic example of an exposed position with 100% risk. To protect your investment against a possible drop in price, all you need to do is give the order to your broker to buy him a contract in the money PUT closer to current price.
A put contract is a legal agreement that commits a package of 100 shares and in which you purchase the right to sell this package of 100 shares at the price agreed future. For example, the contract Put in the money closer to $ 12.46 has a strike price of $ 13. In other words no matter if in the future the price of GE is down to $ 2 you have already purchased the right to sell its 100 shares at $ 13/accion. What is my risk and my total cost? The cost of this insurance will be linked over the life you want for your contract. For example, if I buy now a contract with a maturity of 19 June 2009 (129 days before the date) then the cost of each contract is $ 234. Total investment: 100 shares of GE = $ 1246 a contract PUT JUN-09 = $ 234 Total Investment (No fee) = $ 1,480 Total Risk = $ 1,300 – $ 1,480 = – $ 180 means that your maximum loss is not $ 1,246 but $ 180. In other words you reduced your risk by about 85%!. That’s the magic of the information and knowledge!.