The
last article mentioned a few strategies to help you prevent
losses in options trading. In this article I want to expand
on the first and second strategies.
Before I focus on the strategies, I feel I will be remiss
if I do not mention the importance of developing a plan.
Careful planning is vital to trading and investing. This
plan should include the amount of money you want to risk,and
your personality type, i.e. are you impatient or do you spend
too much time analyzing your trades.
Once your plan is developed and you are ready to trade,
you should know your exit before you place your trade. Reviewing
the IBM trade in our last article, before you purchased IBM
you would know what your projected profit is and what your
stop loss is.
Now, here is what I might have done
with this particular stock (IBM). First, be aware of how
strong or weak the stock
market and sector are, before investing in it. For Example:
IBM is in the computer sector which is in both the Dow and
the Nasdaq broader markets. Once I determine what the broader
market and sectors are doing, I will look at IBM’s
chart. You may simply want to check its fundamentals.
The charts will tell me where to enter, where to target for
profits, and where to exit. In the last session’s example,
I stated that you could have done at least four things:
1. Predetermine what you are willing to lose. I may not want
to lose over 20% of my profit. So if IBM gets to $100 (declines
20% of 125 ), I will sell. It's That simple, If for some
reason, I do not want to sell.
2. I could sell a call against the stock. If I think IBM
may correct over a period of 4 months, I could sell a Jan
2003 140 call and collect the premiums.
3. Alternatively, I could buy a put. If the month i'm in
is January, I might buy a June 120 put. This way only $5.00
would be a loss. If IBM should move to 90 (which it did)
before June, the money I’d make on the long put would
offset my loss below 120.
4. Sell a call and buy a put. The money realized from the
call could pay for the put.
The first principle is to sell when you have reached your
target or sell if the stock declines in value.
If you do not want to sell your stock however, we can go
to the second strategy. Sell a call against the stock.
Assume IBM reaches $125 (you bought at $95) and you think
it may correct. In this month of June, I might check the
June, July, August $135 call options for premiums. The June
month is not offering a good premium. The July is offering
$4.00 for the 135 strike and the August may be offering premiums
of $6.00 for the 135 strike. Thereafter, I decide to sell
the August premiums for $6.00.
I have 300 shares of IBM so I sell 3 contracts which gives
me 6x300=$1800.00. What does this mean? It means that I now
have $1800 to do whatever I want, as long as I keep my IBM
shares. If IBM is at 135 by the August expiration date, this
$1800 (which will be worthless) is clear profit in addition
to the profits I made from the stock. In this case, I can
write another call. Perhaps write or sell a December $145
call and take in an additional $5.00 giving me another $1500
profit. But suppose IBM goes to 100 by July. What happens
to the $1800? It is probably worth only about .25 or so.
You can buy that back, close the position and write another
for more profits.
However, if IBM is above $135 at the August expiration,
you will be called out of your stock. This means you will
keep all your profits including the $1800 but you will lose
your stock. This would represent profits of (135-95)=40 +
(6 X 3)=$1840.
This is one strategy that can bring you in additional income
or reduce the net paid for your stock.
Previous Options Articles:
Options Start
Options Article 1
Options Article 2
Options Article 3
Options Article 4
Options Article 5
Options Article 6
Jenyce Johnson
Options Strategist, Trader and Coach
Not a licensed professional
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