Hedged 200 Santander stocks with 2 call options

The door that I left open by buying 2 call options has finally been closed today.

By selling 200 stocks @11.4 having bought 2 September strike 8 call options @2.8 some days ago I effectively locked 60 cents profit per share (120 dollars, 200*[11.4-(8+2.8)]) which is much more than the 19 cents per share of dividends that I lose because of having options instead of shares. But the best of it is that I now effectively have the same amount of possible profit but I limit the possible loss, which was my goal.

So now in the event of disaster, due to European debt problems, if Santander goes down my loss is partially limited to the value of the options, equivalent to a maximum loss up to a stock value of 8. It’s theoretically like getting a free strike 8 put option, even better, since I gained by doing the swap. The other positive thing is that if Santander goes down more than what I consider that it fundamentally deserves I now have the door open to again buy more options and eventually replacing all the stocks by options. If I had not sold the equivalent 200 stocks backed by the 2 call options and the stock would fall I would not feel too eager to add even more options, because the amount allocated to Santander would then become too big for my taste, but now that I did sell I leave the door open to repeat the process if the opportunity arises. On the other hand if it goes straight up I still have the same amount of equivalent stocks, so my gain is not limited by this move.

Given the slight market recovery due to the optimism of Greece avoiding its imminent default by “kicking down the can” I had the chance to do this swap. Eventually I think that the chance of Greece defaulting is very high. Simply because it cannot even generate with taxes enough money to pay its basic needs, so the debt is actually getting bigger every day. Which by itself taken alone is not a disaster because of the small amounts involved, the debt af all the PIIGS is small compared with the Lehman one and the housing leverage which caused the preceding 2008/2009 crash. But the problem is the domino effect, and investors perception of the problem, since if Greece defaults which it probably will, then Portugal and the rest will be perceived as also being able to default, in which case default will be considered by recent history as a very real option in their minds. In which case investors might panic and the cost of borrowing money for Spain, among others, will increase even more than the current high levels, affecting even more Banco Santander’s costs an therefore loans volume and finally damaging it’s earnings power.

In any case even in case of big problems I am fairly convinced that governments would step in and inject money to some banks, some banks would lose all its stock value at the worse, and I do not think Santander will be one of them. But it could make the stock at least temporarely tank. I also think that the default scenario is quite priced in on the stock value but on the other hand chances are high that the stock goes down more, which would be good in the sense that it might provide the opportunity to add more or to at least swap more stocks by options running less risk on the process and protecting that part of my portfolio which I see as one of the most dangerous ones.

Someone told me that a portfolio manager should get paid to avoid risk, not to take it, meaning by risk to avoid capital loss. By replacing stocks by options at a price that I consider low not not only do I limit the loss but I also do not limit the gain.
To avoid the risk of getting caught during the swap process, and ending up with more than I want, it is better to do it this at low prices. Note that this is not an options collar where I would limit the upside, I here reduce risk understood as the probability of capital loss without limiting possible gain. Oh and what is a nice side effect of the options power of leverage: I use much less money.

disclosure: long

Cheers!
jrv

About jrv

I was born in Spain and lived in Belgium, Chile, France, USA, Argentina among other places. Currently I am trying to settle down in a wild place. I am "retired", even though now I dedicate more hours "working" for my investments than I ever worked in the real labor market where I used to work in IT and Banking. I am a family man, I have a lovely wife, several sons and one step daughter. I have humble tastes, I like to stay home and read about companies and investments. I started investing at 25 before the internet bubble exploded. I did not know much about investing and liked technical analysis so my results were pretty bad. Fortunately I did not have much to lose. Some years later in 2006 bored of doing only real state investments and with quite a lot of money saved I opened an account in a cheap and excellent online broker and started again. This time I did not want to commit the same mistake, so I decided to follow a model. I heard that Warren Buffett was the best at making money via stocks so I started by reading a lot about him, all of his shareholders letters and several of the books that he recommended. I learned a lot, started applying his investing principles and reading a lot of 10K's. Digested news from lots of different sources. Basically I started buying very good and cheap companies and holding them for ever if possible and if nothing changed fundamentally. When the housing crisis started I was more than 75% cash. At that time I identified good companies at incredibly cheap prices so I invested most of my savings in stocks. In less than I year I doubled. By the second semester of 2009 I turned my software company into an investment vehicle and dedicated myself full time to it. My wife and I decided to change our lifestyle and moved from Belgium to the beach in a wild country. The goal was to keep fixed costs low in order to be able to live with a minimum 6-8% yearly return but specially to move away from the inhuman life of civilization and to have finally some peace and sunny weather to concentrate better on investing. Now I can think and study about companies 60 hours a week and I am doing great. I can finally do what I want full time and can proudly say that I have never been so happy, specially also with my just born 4th son, my other great kids and my sweet wife who supports me fully while I study most of the day and patiently wait for the opportunity to make a swing ! You can learn a bit more about my portfolio by viewing it at www.kuchita.com/view/sumo.php or you may learn more about me and my family by following the link "Author's site" from the menu above.
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