Protecting the Downside of the stock
CHOOSING BETTER STOCKS AND PROTECTING THE DOWNSIDE In regards to writing Covered Calls, there is always the question: “What if the underlying stock goes down?” I want to quickly say, “So what?” But I’ll refrain. My point is that you can make almost as much of a $7 stock as you did on that stock when its price was $9.
The real question is, “why did you buy this stock?” Was it hoping for the stock to grow in value? Not really though that is always nice. NO, it was for monthly income purposes. However, this is not a consolation if you stock does go down. My encouragement is to not panic.
Just the other day, a friend who had purchased a stock for $5.80 and then wrote the $6 call for 50¢, saw the stock go down to the low $4s. He didn’t have a stop-loss in. He panicked, and sold the stock for $4.80. That’s a loss of $1 but figure in the 50¢ in income and it’s not so bad. Still bad, but not too much.
A week later (about 10 days) the stock was back to $5.60, and it even hit $6 for a few seconds. He could have bought back the sold options, and then resold them on the rise. He could have sold out further (selling more time generates more income). He could have waited it out, and then decided. Don’t get me wrong, there is a time to sell, a time to weed the garden, it pays to weigh things out.
I personally hope you read my books and subscribe to WIN, Thousand Dollar Thursday. This service is like an on-going seminar, and better than that, we’re discussing real trades all of the time.
I have not changed. I keep at it, trying to improve. No one wants a stock to go down. That’s why the first strategy of protection is to choose stocks wisely. I really believe in the fundamentals of a company, meaning that I look to earnings, earnings growth, debt or the lack thereof, and other factors which speak to the health of a company. That desire has not changed.
However, in looking at the different ways to cash-flow the market, we look specifically to the strategy and then try to find stocks that fit that particular strategy. Writing Covered Calls is no different. It is a unique and exceptional strategy for making income. Everything about this technique shouts out to be known, understood and used. There is one problem with Writing Covered Calls, beside that fact that it is relatively boring, and that is protecting the underlying stock movement in a downward manner. But isn’t this the case with any and every strategy in the market.
I will address some specifics in a moment. First, let me remind you we are fellow travelers on this cash-flow quest. We are students first, educators second. We may tout our experience, etc., but we are not professional brokers, we do not know your personal situation, and we do not manage money. We are in the trenches, just like you, and we like it there. We hope you also appreciate the fact that as pure educators that we get nothing out of what you do.
On to the specifics. We state emphatically, and constantly for our members to check with their own stock brokers and other professionals for trade suitability. We also teach and share many enlightening lessons, commentary and insights into how to choose stocks that make sense for the strategy. For example, many of the stocks we’ve used (ARWR, MNKD, XOMA, KNDI, TSL, and a host of others) have performed very nicely. Sometimes I think we should be in the stock picking business. Then, I slap myself and come back to reality.
The Writing Covered Call method has specific characteristics. Some of the fundamentals are put on the shelf, but not too far back on the shelf. We look to the premium, and the market—like earning’s seasons. We can always do more to improve our skills (and help you improve yours) as to exit and entrance points.
Here are a few things you and all of your fellow members can do.
1] Study the section in Paid to Trade (the 10 lesson plan that supports your membership). Really get in to the P/E section, and other aspects of fundamentals.
2] Make sure you have in your trade the stop–losses. This is key. Many people forget. One stretch, we had about ten really well performing stocks. Then NIHD came up. The stock seemed okay, and the options were nice. With the stock at around $2.50 and $3.00, there needed to be a stop-loss order at around $1.70 to $2. The stock went down. It’s sad, but who cares if you’re out of the stock?
Some thoughts on stop-loss orders:
- There is much more on Stop-Losses in the Paid to Trade lesson plan. Read it and figure out which of the three places to place the order you will use.
- When in doubt, place the order about 10% to 12% below where you purchased the stock. This will help you avoid most problems.
- Many people use the “Revenue Neutral Trade” method. If you buy a stock for $6, and you take in 70¢ for selling the call, then set the order to sell on a dip at around $5.30. This way you’re at least at break-even.
- Don’t forget this, and then think about selling the option again on the next rise.
- You can also set trailing stop-loss orders, meaning that if this $6 stock moves up to $7, then resent your sell order to $6.30 or so.
- As in all of our type of trades, one should consider the exit before going in the entrance. This includes an order to sell the stock on dips or weakness.
- Also, remember in determining which strike price to sell the stock for, and even the date of expiration, to ask the main question: “DO I WANT TO SELL THE STOCK?”
Over the years, in my own account, and definitely in the accounts and trades of countless students, there has been one refrain—even though I and others have a slight problem with stop-loss orders—and that is stop-loss orders, “saved my butt.”
As fellow travelers we have a passion to improve. We show the deal, give commentary—including cautions and concerns. We love your question because it gives us an opportunity to clarify who we are. The point is: You learn and you earn. We get nothing out of what you do. An early church leader said: “I teach people correct principles and let them govern themselves.” That is appropriate here.
We will always try to improve and we will stay in the learning mode as we continue to teach. We have plenty of energy for this task.
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