Post edited 1:37 am – September 22, 2009 by spreadtrader

These call purchases are acceptable trades except that the stock price has to go up in DRYS and EXM for you to make money on each of them. DRYS has to be over 10.00 in mid-December and over 11.00 in mid-January to triple your money on those trades, while EXM has to be at roughly 10.50 in mid-March to double your money there. Can it happen? Sure, but who the heck knows where these under performers in an unfavored sector will be by then?

Compare those straight call trades with this idea….be sure to look at the charts. Buy 100 shares of KSP. Monday's close was 20.12. At the same time, sell 1 October 22.50 put for 2.40. Also buy 2 October 20.00 puts for a total of 1.20 (.60 cents X 2).

Here's what can happen with this trade:

a) the stock price can go over 22.50 by October 16 (option expiration) and all options expire worthless; you keep the 1.20 net premium and in November you get paid a .77 cent per share dividend on the shares you bought (assuming they still pay it); or

b) the stock stays above 20.00 but below 22.50 by October 16^th and the put you sold makes you the proud owner of another 100 shares by assignment at a net cost of 21.30 (22.50 – 1.20), whereupon you promptly collect an additional .77 cents per share for those shares put to you when (if ) the dividend is paid in November; or

c) the stock price falls below 20.00 per share by October 16^th and the same shares are put to you, however, you exercise your 20.00 covering puts and exit the trade with a net .71 cent per share loss on 200 shares (20.12 + 21.30 = 41.42 / 2 = 20.71 – 20.00 = .71 cents)…..clear as mud?

Of course, there is more money on the table when you factor in the price of the stock you buy, but the risk is less than the straight call trades. Once the October options expire you will need to assess whether it is prudent to buy November or December puts to protect the stock position (if you are still in it). But I like the idea that the market doesn't necessarily have to go up for you to make money (it just can't go down); and I also like the 15% dividend yield on this “3 for 5” stock that is right against strong trend line support on both point & figure and candlestick charts. I also like the fact that whatever happens in this trade, it takes place no later than October 16^th except for the dividend payment; and you could just about take a vacation for almost a month while the trade develops.

Be sure that you and your broker are communicating in the event the stock is below 20.00 on the October 16 close so that you can either make a clean exit or sell the puts and lower your cost basis in the shares. 

Next, consider what will you do on October 19th if you still own 100 or 200 shares of the stock. Stated otherwise, if you don't have a plan, you should make one. Come back and tell us what some of the alternatives are that you might pursue. This is good hands on experience, eh?

Post edited 8:44 pm – September 26, 2009 by spreadtrader

Will, I've been out of town for a few days, but your question is not one that I can answer.

First, I assume that when you did the trade you understood that the multiples I used were for the sake of illustrating proportion. In other words, the idea was to buy 100 shares for every put you sold and buy the sum of the shares and sold puts to cover the position. So you could buy 200 shares, sell 2 October 22.50 puts and buy 4 October 20.00 puts; or you could buy 100 shares, sell 1 October 22.50 put and buy 2 October 20 puts, etc.

How much of your account total that you want to allocate to the trade is entirely your decision. I can refer you to resources on position size and account allocation (anything written by Van Tharp comes to mind), but you have to decide how much to commit to any one trade.

Second, I'll venture this. The answer to your question should be another question….how much of this stock are you willing to own? Just like the maxim that you shouldn't sell covered calls on stock that you mind having called away, you shouldn't sell puts for stock that you're not OK with owning. So if you sell 10 more puts, ask yourself whether you want to own another 1,000 shares of the stock.

As I've said in many other situations and examples (TBT being the most recent, I think), don't bet the farm on any one trade.

Enjoy the weekend.

Here is an update on KSP. Stock went up as high as 23.5. Sold at 23.25 and took in about 15% profit. Kept the three Dec 20 puts which jumped up 1000% this morning on some poor earnings report. Sold them in a hurry to rack up my first 10-bagger, albeit in an option. Realizing that KSP is actually a pretty decent stock, I went back in got a few Jan 15 puts with a portion of the profit.

Will said:

Here is an update on KSP. Stock went up as high as 23.5. Sold at 23.25 and took in about 15% profit. Kept the three Dec 20 puts which jumped up 1000% this morning on some poor earnings report. Sold them in a hurry to rack up my first 10-bagger, albeit in an option. Realizing that KSP is actually a pretty decent stock, I went back in got a few Jan 15 puts with a portion of the profit.

This demonstrates the power and flexibility of protecting positions with puts. Selling the stock at 23.25 was fortuitous, yes? However, If you hadn't sold you'd be feeling no pain because your puts would be almost completely covering the losses on the stock.

On the other hand, had you continued to hold the stock naked with no puts presumably you would have had a stop in place to “protect” you. Looking at the chart though, how would a stop have helped you? The answer is “it wouldn't have helped”. At the very least you should consider protective puts for any stock you are holding near an earnings release; and observe that the effect of negative earnings statements can be exacerbated at a time when the general tide is going out.

Congratulations on a very nimble trade.

Will, you're a decisive guy and that's a good characteristic for a trader, but there's a line between “decisive” and “impulsive”. Don't be in such a hurry. Ask yourself what kind of time horizon you want to take to optimize your investment results. Take some time to let the market digest new inputs. Watch, plan and then trade. Perhaps you planned in advance for KSP to drop almost 1/3 of its value and then executed the plan to sell puts on the same day as the decline, but if you didn't you need to examine a potentially dangerous tendency. I fiind that when I make reactionary or nearly instantaneous decisions trading it almost always hurts my account.

Here's an exercise for you. Whether you think this move down is a correction or a resumption of last fall's crash, start planning for what you will do within the next 30 days in response to the recent market action. Have that plan, envision what will probably happen over the next 6 months and plan to trade with that as a horizon. Most of the time, taking your time is the best course.

Reminds me of the somewhat off-color joke about the old bull and his son standing on a hill overlooking a meadow of eligible cows. (I'll try to clean it up some.) The young bull says to the old bull, “hey dad, let's run down the hill and have some fun with one of them cows”. The old bull drawled, “no son, let's WALK down the hill and have some fun with ALL of them cows”.

…..have a great weekend.