[TheOptionClub.com] Re: how to manage risk [was: While I do not trade covered anything]

 

Actually, sometimes I will buy an out-of-the-money put when selling
puts. You're technically in a vertical spread when doing this, but I
suppose it's a matter of mind set.

For example, RIMM recently announced earnings. The implied volatility
on the at-the-money puts was pretty high and I was tempted, but cause
RIMM is a stock that I would not mind having in my retirement account.

Two days prior to the earnings release the premiums were pretty fat, so
I sold the at-the-money puts with the intention of accepting assignment
should it occur. What if RIMM disappointed? I was okay with a little
disappointment. But, what if they REALLY disappointed. In that case I
wanted a little protection because I could envision a scenario where
earnings are released and RIMM drops significantly before an order can
get filled.

I wanted to protect against a possible gap down, so I actually sold a
wide vertical put spread by buying the out-of-the-money puts and selling
the at-the-moneys. This way I had some protection against disaster, but
the basic trade was selling the at-the-money put premium. Sort of like
buying insurance with a large deductible.

You're right about stops and market orders, by the way. You'll get
screwed a bit on the bid/ask spread, but keep in mind that a stop is
like pulling the ejection seat lever. You only do that if the plan is
plummeting from the sky and you're willing to suffer a broken vertebra
or two to get the heck outta there. That's how I look at stop orders.
Just get me out...

As for that RIMM trade, there was a happy ending. Earnings were good
and RIMM rallied. I bought to close the short puts the next morning,
let the long puts expire worthless, and made a nice return for the 24
hours I spent in the position.

Christopher Smith
TheOptionClub.com

--- In OptionClub@yahoogroups.com, "anatolemclubs" <anatolemclubs@...>
wrote:
>
> Chris, great post. I had a question. Why do you use a stop instead of
just buying an OTM put at or near your stop point? Do you find the
option premium of the OTM put is not worth it? Or is there some other
reason? The downside of the stop loss is that if it's a market order
you'll likely get dinged the bid/ask spread which could be quite wide in
a rapidly falling stock no?
>
> Thanks.
>

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