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1 PUTS AND CALLS FOR THE CONSERVATIVE INVESTOR Common Sense Strategies By Edward M. Wolpert Oconee Financial Planning Services Conservative investors can enhance their earnings or reduce their risk by the careful buying and/or selling of puts and calls. Puts and calls are options to sell or buy an underlying security at a given price, the strike price, on or before a given date, the expiration date. When you buy a put or a call (you are the buyer or owner or holder of the option), you have the right but not the obligation to buy or sell the underlying security. When you sell (you are the seller or writer of the option) a put or call, you have the obligation to deliver the underlying security if the option is exercised. Puts and calls are traded on several exchanges. Sophisticated traders with fast access to the markets and advanced tools to identify arbitrage opportunities use puts and calls combined with risk-free investments and/or other investments in order to make short- term financial gains. The strategies discussed here are not aimed at such financial professionals. Rather, they are meant for conservative long-term investors. What characterizes conservative long-term investors? Generally, they seek growth in their portfolios through buying stocks representing good businesses—companies that are well managed, have a good future, generate cash, have reasonable amounts of debt, and whose stocks are listed, liquid, and marketable—and do this buying when the share price is undervalued or reasonable valued. They tend to hold stocks for three to ten years or even longer. They are optimists who are long-term bullish on the economy in general and certain industries and stocks in particular. And with discipline, focus, patience, and a modicum of luck they usually become rich over time. Investors such as this may fine tune their portfolios with the discrete use of options for purposes of generating additional portfolio income, protecting and/or hedging and/or leveraging existing long positions, and specifying a target date for buying or selling a stock. If you buy a put or call, you may or may not choose to exercise it depending upon whether doing so would be profitable or not. If it is profitable to do so, then you exercise the option and take your profit. If it would not be profitable to exercise the option, merely let it lapse; you will forfeit the premium you paid for the option, but you will not be risking the capital necessary to have bought the underlying stock. The buyer/owner/holder of a call (referred to as being long on a call) has the right to buy a security at the strike price on or before the expiration date for which the buyer will pay a premium to the seller. The seller/writer of a call (referred to as being short on a call) is obliged to deliver the underlying security if the call is exercised. If the call writer does
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2 not have the stock to deliver, he will have to purchase it on the open market to provide timely delivery. The buyer of a put (long on a put) has the right to sell a security at the strike price on or
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This note was uploaded on 05/20/2011 for the course ECON 5128 taught by Professor Ram during the Spring '11 term at Cambridge College.

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