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