I thought about employing stop losses. You seem to have some concern about that. Care to expand?
Sure. Lets take the stock you mentioned, NUFO. On Tuesday it traded at $15 (or above) for most of the day, so lets say you bought it for 15 and you sold a 15 call at 1.50. Now where do you set the stop loss? Some would say 10% below the stock price which would be $13.50. That's a possibility, but it is probably too tight, since on Monday the stock was below $13.50 in the morning and it can certainly fall there again on a temporary dip. You could set it at say 12.50 but lets say the stock hits that level on Monday. It's possible, it closed today at 14. So you are stopped out at 12.50 which gives you a 2.50 loss on the stock and the option, now naked, is still open. Sure, its premium has dropped, perhaps down to 0.75 and you have to buy it back so now you are out 3.25 against the 1.50 you made selling the call - plus commissions (and spreads) on four trades.
The trouble with stops is two fold. First stocks can be volitile. It is not unusual for the stock on my screen that is up the most one day to be the stock down the most the next. Just because a stock falls, does not mean it will not turn right around. Also, if you troll these boards you will read plenty of sad stories about people who lost their stock to market makers who brought the price down just to scoop up the stops. Remember, the market makers can see your stop orders. Sometimes, if you watch time and sales data you can see trades going off at quite different prices. If you get taken out on a dip that lasts three seconds you probably have no recourse. You can call your broker and complain but they will say "fast markets" and that will be the end of that.
To avoid this problem some people use mental stops. "I will sell this stock if it gets down to 12.50 no matter what." Then, Murphy's Law, after a week or two of smooth sailing, one day while you are having lunch the stock drops to 11.75. You get back, you see it, you feel sick, but wait it seems to be ticking up, look now its at 11.85, now 11.90 OK I'll sell as soon as it gets to 12.50. You know the rest, next time you look it's at 7.80 because they just missed earnings and the CEO quit.
And one last point. Just because you have a 12.50 stop does not guarantee that you can get out at 12.50. The stock might close one day at 12.75 and open the next morning at 10.
StockHawk
PS. please keep in mind I'm not trying to discourage you from trying a new strategy. Clearly, any strategy can be picked apart and be made to look risky. Buying stock is risky. Crossing the street is risky. The important part is to be aware of what can go wrong, this way you can deal with it effectively. Good luck! Keep us posted and we will all learn together. |
