Option Investor
Educational Article

Here We Go Again!

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By Lee Lowell

Arrgggg!!!!!!!! Is anyone else feeling the same as me? Angry, frustrated, ticked off, etc., etc. Why can't this market just go up and keep going up? We've endured these downmoves, now let's see the reward. I was really excited to see the presidential race so close, but enough already! It's wreaking havoc on the markets and facilitating this bear move. I guess the numbers from Dell and HWP hasn't helped much either but...

Last week I got into some deep-in-the-money LEAP calls on stocks that I've wanted for awhile and sold some near-term ATM calls against them. Some of the near-term calls were even slightly ITM. Even so, I'm already in the red. Jeez, at least give me a chance to play awhile! If I'm going to lose money in this market, at least let me bleed for a few months instead of whacking all of me in 2 days time! You can see by all the exclamation marks that I'm really in a mood.

It's not like I just haphazardly picked any random stock to buy LEAPs on and then threw some darts to see which near-term calls to sell against them. These were well thought-out plays, with research done on support and resistance points, implied volatility analysis and probability calculations to boot. I guess we just hit one of those times where all the research in the world won't help with your selections. There are lots of unnerving factors at play here and they all spell uncertainty, which is something that the markets don't like. I need to remember that buying LEAPs gives you the comfort of time working in your favor. But what should you do when you come very close to hitting your stop-loss or even through your stop-loss level in 2 days time? I have over 2 years to play with but I'm very close to losing as much money as I care to on these trades.

This is the hardest part of options trading. When you need to make tough decisions. I truly believe the stocks that I just purchased were based on solid research, and knowing that there's lots of time left, I'm going to ride it out a little longer. I have to believe that once the presidential fiasco is rectified, we'll sense the stability and see the market stand on some solid footing. Emotions are running high and that's what causes these extreme moves. I know you set your stop-losses and stick to them, but for me, I believe this is a special case of irrational selling and I'm going to hold for a little longer. Every trader reserves the right to make these decisions. We'll see how it plays out. Look it, the Nasdaq has basically made a 100% retracement, there are many individual stocks that have made 100% or more retracements from last October's lows when we started the last bull run. The sentiment indicators that I use are at extremes for a reversal - put/call ratios and VIX. You have to believe something. As for newer picks right now, I'm staying on the sidelines and will just try to manage what I've got so far.

What's there to do in the meantime? Not much that we haven't done already. If you're here to trade, and by that I mean getting in and getting out for a quick turn, then you must place your stops and stick to them. If you're here to trade long-term calls, then I believe sticking it out a little longer is probably the right move. That's where I am right now. I'm just going to keep selling the near-term calls against my LEAPs to decrease my cost basis. Mind you, these are my long-term holds. I can take a little down- side pain because I believe it will run up in the long-term. But to try to make back some of my recent hits, I'm going to sell some front-month credit spreads on high implied volatility stocks.

As I finish writing this today 11/14, the Nasdaq has made quite a nice comeback from yesterday's low of 2860. We're trading right around 3100. Have we hit the bottom? Maybe. Some people were saying that last week when we retraced the previous lows of 3087. We're right at the level of last Oct/Nov when we started the last good move. I guess many of the stocks I bought late last year which are basically at the same price now as they were then are still a good buy? Maybe. If I still feel the same about the company's prospects, then yes, they are still good buys. I don't think we'll see that incredible run-up as we did late last year only because people are wiser now. Investors who got in at the top and got burned on the downdraft, will not bid prices up like that again. Or that don't have the money anymore even if they wanted to try again.

I'm wiser now too. From now on I won't trade any stock that doesn't have options available. Remember, options are a great protection against existing positions. You've heard this one before - you buy life, car, home insurance, why not buy stock insurance. We pretty much accept life, car, home insurance as a given and something that's done automatically. After all, these are the most precious assets. If you don't insure yourself, you risk the chance of losing everything in an unexpected event. But if you lose all your money in the market, you'll also end up with nothing too, so why not use all available resources? Buy some puts and sell covered calls. It's a few extra dollars spent in the case of the puts and a few dollars brought in, in the case of the calls. You'll sleep a lot better at night knowing you're protected.

I've gone into pretty good detail in previous articles on various strategies you can create to hedge yourself on the downside. Remember to check the volatility levels before applying any of the methods. Selling a covered call might be the better play than buying the put if implied volatility is high. Collars and debit put spreads are also good candidates for protection. Your choices are almost limitless on the kinds of strategies you can construct. Remember the key word - options!

Good luck.

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