Tuesday, December 28, 2010

Lock in profit

Two ways to lock in profit!

Investing for income can be a passive activity.  Buy stock in companies that make money, companies that share it with you in a dividend, have a strong balance, and periodically raise the dividend and you can sit back and spend your dividend income, cash your bond coupons, and build your cash through covered calls.

However, investors that are more active tend to enjoy locking in profit when they have a stock that has substantially increased in price since they bought it.  It makes sense to take profit.  You can always buy another stock or buy back the one you sold if it goes down to a lower price.

How do you protect profit? 

Let me count the ways and two come to mind.  One is to use an option strategy called buying a "put."  You already know one option strategy and that is to sell a call.  Selling a call is a strategy to increase income.  Buying a put is a strategy to lock in profit.  

We income investors use covered calls all the time to maximize our income.  To refresh your memory, selling a call on a stock that you own conveys the right to another person to buy your stock at a predetermined strike price over a defined period of time.   The other person pays you money for that right.  

A put, on the other hand is an absolute obligation.  A person must buy your stock from you at a predetermined price, again over a defined period of time, if you demand it.  In the case of a put, you pay someone money to be able to demand they buy your stock.

I rarely use put options because as an income investor, I do not like to payout money; I like to make income.  So how do I protect profit and not have to  pay out money.

I protect profit by placing a sell stop order.  I tend to use stops on stocks where I have at least a 20% gain.  I try to lock in a price that is about of 10% from the high as long as that price is greater than the price I paid for the stock.  I lock in some profit and do not have to pay for the put protection.

I tend to comb through my holdings for stocks that are at a high and set stops for safety or buy a put to lock in my gain.

Yes, income investing can be a passive sport but for those of you who are active investors, consider employing one of these two techniques to lock in profit.

Very Truly Yours,


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