The market has been fighting us this week but so far the damage is minimal.

F5 Networks has fallen off the cliff this week on no specific news. The recommendation for Tuesday was to try and enter the play again with a lowered strike. FFIV was technically positive for about 30 seconds at the open before imploding again. It was positive for such a short period I doubt the options had opened for trading before the stock had fallen a couple dollars. I seriously doubt anyone managed an entry in those few seconds so I am going to drop the recommendation as unfilled.

FFIV Chart

Our second problem was a Citigroup downgrade of Veeco Instruments to hold from buy saying they see "heightened risk" in the first half of the year due to a policy change in China that could delay orders. VECO shares fell -15% on the news.

Our stop loss was $47.75 and VECO opened at $47. That took us out of the position at $2.40 on the option and a loss of 40-cents. Given the severity of the decline (-$8) we really got off lucky. It also emphasizes the importance of stop losses.

I received an email from a reader today in reaction to the drop in VECO and FFIV.

I was curious how you decide to set the stop losses for particular options. Are you limiting losses to X%? What metric do you use?

I set stop losses based on the support levels on the stock itself. I found out many years ago that stops on options did not work for me. I was instrumental on getting our favorite broker at the time, Preferred Trade, to add options stops based on the stock price. They were the first of the major brokers to add that feature. Now everyone offers it in some fashion.

When you set your stops based on support levels on the stock price you have less of a chance of being stopped but you may have to give up a little premium to do that.

For instance on a $100 stock with a $5 call option you may want to set your stop at $97 but support maybe $95. Setting your stop at $97 would put you in the range of any volatility swings and stop you out for a $1 loss. If you reentered the position you could continue to be stopped out on those swings.

By setting the stop under support, say $94.50 you have a much better chance of avoiding the volatility swings and remaining in the position as it moves higher. The downside is a touch of 94.50 would stop you out for possibly a $2 loss.

There is no perfect system. I prefer to stop under support because I have found over the years I lose less money being stopped out less than being too conservative and getting stopped out on any bout of volatility.

You have to decide personally where your comfortable. You don't have to use my stops. You are free to pick your own. It is after all, your money.

I also try to avoid round numbers. If support is $40 then I try to use something like $39.65. Traders will park buy orders just below the round number support. I want to be just below them. The extra 30-50 cents on the stock price is not going to be material on the option price but it will help avoid quite a few stops.

You may have noticed many times over the last year when we missed being stopped by just a few cents on quite a few occasions. Those were not accidents. Where you place your stop is important.

Jim Brown



Current Portfolio




Current Position Changes


None


New Recommendations


None


New Long Term Recommendations


None - Waiting for a "real" market dip


New Aggressive Recommendations


None


Margin Requirements:

There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.

Here is the most common margin calculation for naked puts.

100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))

For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)