I like it when I write about a stock after it has just fallen hard. Catching a good falling knife can be sweet. Nio (NYSE:NIO) stock took a tumble yesterday on no particular news.
In comparison, Tesla (NASDAQ:TSLA) only struggled a bit in the morning then closed up 1%.
This was on a day when markets broke records yet again. So far, the dips in NIO stock have been opportunities to get a long position. Today the message is no different, so it’s a rinse-and-repeat strategy of catching the proverbial falling knife.
The trick to doing that successfully is to choose entry points at or near prior bounce levels. On Thursday, NIO came pretty close to one and another below it.
My assumption today is that support will hold one more time near $33.75 per share. If not, then it has a back-up just below it $32 per share. But it is also important to set stops to get out if the assumption is wrong.
Therein lies a warning that if those two fail, there will be big trouble. NIO stock could fall as low as $20 per share. Under the current conditions, I don’t see that scenario unfold without a major market-wide correction. If my support thesis proves correct, the reward is a long swing-trade higher. There are many methods to monetize this. Buying shares is the traditional one and most investors do it.
Get Long Nio Stock with Smaller Risk
There are cheaper ways to consider using options. They lower the out-of-pocket expense, thereby putting less up-front risk at stake. This is important because the indices are at all-time highs and far beyond the limits. The less risk I take now, the better. Balance matters, so this is the time to explore new skills in trading.
Buying NIO shares at face value has no protection. If the stock falls, I start losing money immediately. Alternatively, I could risk a lot less by buying NIO leap call options. The cost is much smaller and the profits would offer a bigger bang for the buck. Options profit a lot faster than the underlying equity. But that’s a knife that cuts both ways, so they will also lose value at blinding speeds.
That’s why I favor another way to use options. It requires no out-of-pocket expense and leaves a lot of room for error. Instead of buying 1,000 shares of NIO, I could sell 10 May $30 puts instead. For that, I would collect $1,000 today for promising to buy the shares at $30. The contract has 35 days on the clock and I don’t even need a rally to win.
Place Buffers Ahead of Risks
By selling the puts, NIO can fall another 15% and I can still win. My break-even point wouldn’t be until it falls below $29 per share. The downside of this is that it has limited upside. The most I can profit is what I collect up front. But that’s a small price to pay for a 15% cushion. These sold puts would expire before the earnings report and that is important. The short-term reaction over the headline is completely binary for two reasons. First, we don’t know what the company is going to say. Second, we don’t know what the investors are expecting from it.
Those who are really aggressive NIO stock can do both. They can sell the puts to create income, and buy the calls to create upside leverage. Doing that now is overkill just because of the extrinsic risk from markets. I’d rather start with one side first, and then add the other when appropriate.
There is a misconception out there that options are more dangerous than stocks. Options do move fast and they are time sensitive. Therefore, they have the potential to be more dangerous than stocks. However, using them responsibly actually mitigates risk.
It’s a Matter of Rinse and Repeat
Compare the scenario of someone who buys the shares today versus me selling the $30 May put. And let’s assume the stock tumbles to $29 per share. At that point, I would still be at break even. The person who bought shares would already be down 25% on their investment.
In fact, I have proof of concept since I wrote about this is exact strategy late February. The trade setup yielded an easy win. Someone who held on to the stock since then would be now down about 30%. The danger with options often stems from the lack of discipline. Investors who buy them willy-nilly create potentially loser situations.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.