A better way to profit from falling stocks

Shorrible sellers have a bad reputation. They are often vilified by the media for “ganging up” against ailing companies or even causing stock market crashes.

There is little evidence to support the latter, however, and the truth is that short sellers are a necessary part of the market. They help provide liquidity and control overpriced stocks.

I don’t know about you, but I don’t just make profits on the rise. There is an extraordinary amount of money to be made on the downside, especially in a market like this.

But when you sell a stock short, you risk unlimited loss for limited gain. I’m a probability guy, and I don’t like those odds.

Additionally, there is a profit strategy when stocks fall that offers limited risk and substantial (but not entirely unlimited) gains. Given this, I don’t know why anyone would choose to sell stocks short.

Now my strategy involves options, another area of ​​the market that has a bad reputation. But unlike short selling, options – when used correctly – can actually help limit your risk.

Today I want to explain how to use basic put options to profit from falling stocks. To do this, I am going to use an actual trade that I have recommended.

Last summer, after taking a look at the weakness in the Dow Jones Transportation Average, I warned that one of its components, a US rail company, was on the verge of collapse. The stock in question – Kansas City Southern (NYSE: KSU) – was significantly underperforming the overall market and had lowered the overall transportation index.

With stocks trading at $ 99.23 at the time, I was anticipating an 8% drop to $ 91. But rather than advising traders to sell KSU short, I told them to buy a put option on the stock.

A put option gives you the right (but not the obligation) to sell the underlying stock at a certain price (the strike price) on a future date (the expiration date). This allows you to profit from the fall in the stock with less risk than selling it short.

Specifically, I recommended buying the $ 105 exercise options that expire in December for $ 10.30 per share.

Since each option contract controls 100 shares of the underlying security, the transaction cost us $ 1,030. It was still a lot cheaper than selling 100 shares of KSU short, which would have cost at least $ 4,961 on a 50% margin.

The most we could lose was the option cost of $ 1,030. The losses for a short seller, on the other hand, were theoretically unlimited because you don’t know how far a security can go. But I also advised readers to add more protection by placing a stop-loss at $ 5 ($ 500 for the contract), so the most we risked was $ 530.

The target was for KSU to fall to $ 91 upon expiration in December. At that price, the put option would be worth at least $ 14 (strike price $ 105 – share price $ 91) and offer a return of 35.9% in four and a half months.

This was the maximum time to open the deal, but I predicted that we would only need until the end of October, after the company reported earnings for the third quarter.

Instead, KSU started to fall like a rock immediately after my recommendation, hitting my target in just 17 days. This translates into an annualized return of 771.3%.

Last week I recommended another put option on KSU. Despite weak income and other growing bearish factors, stocks have made a miraculous 35% rally from their January lows and look expensive again.

Perhaps this rally was fueled by extreme profit taking from the growing number of short sellers, but whatever the cause, stocks are now ripe for a pullback.

This time, we’re only risking $ 610 and we should see a 17% gain in 101 days, or 61% on an annualized basis. But if it’s like the first time, our target will be met much sooner and our annualized profit will be much larger.

Since I started my Profit amplifier service a year ago, the average put options trade had only been open for 26 days and generated an annualized gain of 918.1%.

If you’ve ever considered using options, my strategy may be of interest to you. I use it to trade put and call options, which allows me to make money whether stocks go up or down. In fact, I developed it when I was 16, and by 18 I was making $ 600,000 a year with it.

I have refined it over the years and it has made me millions. But after a life changing event , I decided to quit Wall Street and start sharing it with average traders.

If you want to know how it works or see more of my trading recommendations, follow this link .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

© Copyright 2001-2016 StreetAuthority, LLC. All rights reserved.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


Source link

Leave a Reply

Your email address will not be published. Required fields are marked *