This trading example shows the buying of stocks or CFDs with Insurance (buying a Put).
It is used when you want 100% downside protection of your capital and are prepared to pay for the insurance to get this. To make this strategy work, you need to select a stock that you expect to move enough to cover the cost of the insurance, plus make you a profit.
In the example below, we are buying 20000 AMC stock for a total of $132,000 and we are also buying insurance of $9,800.
This strategy is perfect for CFDs or 100% borrowing to buy the stock, because the capital is protected.
You can see in the Payoff diagram below, our exposure is limited to the cost of the Insurance ($9,800) plus the difference between the stock price and the option exercise price (ie how much the stock can fall before the insurance kicks in), in our example a total of $11,800. We also have the interest on borrowings or CFDs to pay which is normally calculated daily. If the stock pays dividends then this can be used to offset the interest.
If you look at the Trade Analysis section, you can see that the stock will need to move up by 7.4% for us to break even. This is a stock price of $7.09 which is where the blue line in the payoff diagram cross the axis ie $0 profit.
Note, if using stocks as the vehicle, you receive dividends with franking credits. If using CFDs you receive dividends WITHOUT franking credits.
If using CFDs you will need to fund 10% of the stock purchase price as Initial Margin. But you get this back at the end of the trade.
The benefit of CFDs in this example is the cost of Brokerage. The brokerage used in this example is based on 0.8% + GST, a total of $1181. CFD brokerage can be much less than this.
This example uses Stocks or CFDs with Insurance in a Bullish trade. When using CFDs you can also turn this around by Short Selling the CFDs and buying a Call as insurance. Remember though, that when you short CFDs you receive interest (a couple of % below the cash rate) but you have to pay the Dividend if one falls due while you are short.
Some people also buy an extra 10% – 20% of Insurance. Whilst this costs a little more, it has the advantage of cutting your loses (the cost of the insurance) if the stock falls sharply. See example below.
Disclaimer: This example is for educational purposes only. It is not intended to be any type of financial advice. For financial advice your should speak to a qualified Financial Advisor or Broker.