Last weekend I wrote about the use of stops in general and in
high volatility markets such as those we are currently facing. A
reader pointed out that I didn't know what I was talking about since
it was his view that stops don't work in high volatility markets and
the only thing worthwhile to protect positions was the protective put.
First, I want to point out that at the worst, it is far better to
have a stop than to have nothing to protect the downside. I agree
with the most recent critic that stops are more difficult in highly
volatile markets and as I indicated last week, more latitude is
necessary in placing them than in less volatile situations.
Truth be told, I am a great believer in protective puts as well.
In fact, I just spoke about them a couple of weeks ago at the
Trader's Library event, went into great detail about them in my book,
"Trade Your Way to Wealth" , and have previously written articles about
them here and elsewhere. For those who may be unfamiliar with
options, a put option is a contract in which the buyer of the put
obtains the right (but has no obligation) to force someone to buy his
stock at a predetermined price (the strike price) anytime until the
put expires. In exchange, the buyer of the put pays the seller of the
put a premium. In return for the premium, the seller of the put has
the obligation to buy the stock at the strike price if assigned (put)
to him anytime before expiration. For example, suppose I owned XYZ, an
optionable stock which I bought at $30 a share. I could buy buy a put
at a $25 or $30 strike price that expires a month or two or maybe even
a year from now. The longer away the expiration, the more expensive
the premium would be and the higher the strike price I bought, the
more expensive it would also be. In the example, suppose I bought the
$30 strike price with an expiration 4 months out and the premium was
$5 a share. Now, no matter how far the stock might fall, I could force
someone to pay me $30 a share if I exercised my put any time before
expiration. Naturally, if I did that, I would be out the $5 a share,
but I would be able to sell the stock, itself, for exactly what I had
paid (less commissions on the stock and on the purchase of the puts).
One thing for which I suspect the critic of stops failed to
account is the relative cost of puts. At times like the present, for
example, where the implied volatility is very high, options are very
expensive. Buying options may not be the wisest things to do at times
when volatilities are extremely high. To look at a real life present
day example (as of close on Wednesday, November 12, 2008), DUG closed
at $45.26. Suppose we bought 100 shares at the close and also bought
the at the money $45 protective puts. We could have bought the Jan 45
puts for $11.90 a share. Now we would be able to force someone to buy
our stock for $45 a share anytime between now and the third Friday in
January for $45. I would have cost us $11.90 a share to obtain that
protection so come the third Friday in January, the stock would have
to be up $11.90 a share (+ $0.26 since the stock would lose 26 cents a
share if we sold it for $45 a share)plus commissions for us to break
even. That is one choice we could have made and it is a legitimate
one. However, we should be aware that the premium we are paying is
quite high because of the high current implied volatility. On the
other hand, we might have chosen to place a stop loss below the
uptrend line on the stock at $37. If the stock dipped to $37, our
position would be closed and if closed around the $37 mark, we would
have lost $8.26, a number significantly less than the cost of the put
premium. Of course, one problem with stops is that there is no
guarantee that we will get the stop price if it is hit.
The stop simply means that our stock will be sold if the stock
price hits or goes below the amount at which the stop is set. If, for
example, the stock gapped down at the open to let's say $20, our $37
stop would be hit but we would probably only get around $20 a share.
With the put in our example, no matter what the stock price, we could
still assign it for $45 if we had paid the $11.90 a share premium.
The real point is to look at the alternatives available to us.
Sometimes the stop is the better choice, sometimes the protective put.
The fellow who decided I was so foolish to discuss stops last
week and took the position that anyone with a brain should only buy
protective puts also failed to acknowledge that many stocks are not
optionable and if one holds a position in such an issue, buying a
protective put is an alternative that simply does not exist.
Returning to the subject of a seminar, although there has been a
fair amount of interest, I have decided not to do one for pay.
Instead, I am going to do a free event for those who have been
one-on-one coaching students. I will contact those individuals
privately. I also am offering those who indicated an interest in the
seminar the opportunity to have a private coaching session for the
same price as I offered the seminar (i.e. $2,100 for paid subscribers
and $2,500 for non-paying Newsletter subscribers). This offer is open
ONLY to those who have already written evidencing a desire and
willingness to participate in the seminar. Please contact Earleen at
MarketFN if you would like the private coaching and she has agreed to
put you in direct contact with me. The private coaching sessions are
designed to address the specific individual's needs and goals and are
geared to his or her level of knowledge and experience. I sincerely
believe these sessions are even more valuable than a general seminar
and they have been quite popular in the past. Other than free
seminars for previous coaching students which I hope to do on an
annual or biennial basis, I do not expect to do any other seminars now
or in the foreseeable future.
Good Trading!
Bill Kraft
Success Trading Group -- by the Success Trading Group Team
Our Success Trading service delivers quality trading ideas for the elite investor that has the financial wherewithal and market nimbleness to profit on small moves in a stock's price. Become a member and you will be provided with email and/or PDA alerts intended to provide you with the opportunity to make many, many profitable trades.
Here is a play from the Success Trading Group:
Pfizer Inc. (PFE)
Our Success Trading Group members scored another winning trade this week.
We traded in and out of Pfizer (Ticker: PFE) on Thursday for a quick same
day gain. Lots of stocks now on the radar for trading including CVX, VZ and
USB. We like USB at current levels for a trade.
Have a great weekend and we'll trade next week.
Success Trading Group Team
