Again, has nothing to do with the world biggest miner BHP Billiton (ASX:BHP), BHP stands for “Buy, Hold and Pray” – it is the oldest and classic strategy that our grandfather or father or some of us still do when it comes to investing in share, but with a bit of twist. We set a protection against a downturn – 100% capital protected.

• As the term reveals, it started with buying some share in the share market. Say we buy 1000 shares of XYZ company for $10 each.
• At the same time, we will buy a put option at strike price $10 as protective put
• Then we hold those share until we reach the target.
• In the mean time, we can really ‘lock in’ our profit by ‘roll up’ the protective put (buying higher strike price put option as the price go up) or ‘roll down’ the protective put (selling the current put and buying lower strike price put).

To really understand how this work you need to understand how option works. Perhaps this article “How Option Produces Profit for Trader” may help. In a nutshell, when the price go down, the put option increase its value offseting the lost value of the stock.

The money

Using this “Protected BHP strategy”, investor make the money from 2 ways:

• Dividend income: only if the company distribute dividend
• Capital gain: when we sell the share and the share has gone up in value (the price has increased)

The disadvantage

There are 2 disadvantages with this strategy:

1. The protective put have a cost. It roughly should average around 1% per month. So, after 3 months, the stock need to go up above 3% before making profit. On the other word, put option for protection make the break even higher.
2. If the stock does not move at all, exactly at the same price when the option expired, you need to bear the cost of put option as a cost (your stock/capital is still protected but this cost will be incurred). Typically it will be around 3% – 5%. This is what I call “insurance cost”.
   As comparison, let’s talk about your car insurance. You pay insurance premium annually, if after one year nothing happen at your car, will the insurance company give back your premium ? OF course not… you actually will pay them another year of premium… This is exactly what happen here. The put option is your insurance, if it’s expired you need to pay another insurance.

But the advantage have much higher value than these tiny disadvantages: the stock is protected for any downturn so your capital will be 100% protected.

Better execution/alternative

Is there any better alternative? In fact , yes there is. Remember that you still need to bear the cost of put option whether the market will go up or down? How about like this: if the market go up: you make a profit less put option cost. If the market go down: your capital is protected (no loss) but also you got back the cost of your put option. I think this is almost what so called ‘perfect investment’ – it will require a little bit more calculation but it’s still simple.

To find out more: goto “Near Perfect Share Trading: NPST”

To see what happen if there is no protection on your share trading go to “BHP: the classic share trading strategy“.

Denis Kristanda