I rue the day Jim Cramer said that a company called Internet Capital Group was the next big stock. Like many, I bought in during the dot-com bubble of late 1999.
ICG later changed its name to Actua Corporation (ACTA), and if you look at the chart, you’ll see that I got in just about at the top, at a pre-split price of $115. As you can see, it still hasn’t recovered.
I sold it for under a dollar. My worst investment ever. If you own Valeant Pharmaceuticals Intl Inc (VRX), you are feeling my pain.
Which brings to mind this question: What do you do when your stock implodes?
Your Stock Is Cratering. Now What?
There are several answers. Let’s use the Valeant situation as a case study. First, use stop loss orders. These are circuit breakers that trigger a sale of your stock at a given price. Most traders suggest having it 7% to 10% below your cost basis.
Once a stock starts delivering outsized returns, I often will move that stop loss up. Conservative investors may want to set a “trailing stop loss,” so that the trigger is always the same percentage below the previous day’s price. I find that too restrictive, as it could get you stopped out of a stock prematurely.
A stop loss is all well and good if the stock craters while the market is open. However, news usually comes out after the market closes. When it opens, it may open far lower than where your stop loss is, and it then becomes a market order. I’ll return to this in a moment.
Let’s say it’s late October and you’re down 50% … outside of stop losses, what can you do?
That’s why options can be so wonderful. If the stock has fallen, it’s time to buy “double insurance.” That means buy twice the number of puts as shares you own. I would make these deep in-the-money puts with relatively near-term expiration, which may cost a bit more, but you aren’t paying a time premium. Effectively, you’re shorting the stock by twice the number of shares owned. When they expire, you repeat the process.
If the stock continues to fall, one of those contracts will offset your losses. The other will actually generate profit and over time, possibly earn back what you lost.
Another approach is to simply sell out and move on. Take the loss (or the gain if you’ve been in for the long run) and capital gains loss deduction. If you’re tearing your hair out over missing some big run up if the whole thing turns out to be nothing, then you can buy calls.
At this point with Valeant stock, however, you are in a real pickle.
Your VRX Stock Options
OK, so things look downright awful. If you’ve held on through this plight, it’s time to cut bait and eat the loss. My gut tells me that it could go under, even from here at $26 per share.
If you’re feeling bold, buy the July $40 puts for $15.60. You profit if Valeant stock falls below $24.40. Heck, it could go to zero by then. Hard to say.
But you may do very well and offset some losses if it does.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
More From InvestorPlace
- 3 Life Insurance Stocks at a Crossroads – Should You Buy?
- 10 Cheap Stocks to Buy for $10 or Less
- SPDR Gold Trust (ETF): A Wave of Bullishness Is About to Lift GLD Higher!