Once regarded as a transportation juggernaut, General Motors (GM) seems to getting towed in reverse by this market, as evidenced by last week’s dismal earnings announcement (a 20% loss in sales, representing a $15.5 billion quarterly loss).
GM is back in the news today as analysts from Lehman (LEH), Credit Suisse (CS) and Citigroup (C) are upping the company’s loss estimates for the rest of the year — that is, on top of the $51 billion the auto manufacturer already lost in the past three years alone. Back then, the stock was trading at $35 a share; now, it’s lucky if it stays above $10 in an average day.
In mid-June, the auto manufacturer was trading at its 25-year low (at $16.50). Just a few weeks later, GM hit its 50-year low on July 8 (at just under $11).
Just three weeks took out 25 years of profits. Clearly, this market is taking no prisoners.
RESTART YOUR PORTFOLIO WITH LOW-COST, HIGH-OCTANE TRADES
Although the occasional Ford (F) owner — GM’s rival — has joked that the company’s name is an acronym …
… for “Fix Or Repair Daily,” Reuters reported that Lehman’s outlook on Ford’s prospects for a turnaround are better than GM’s.
I’m not sharing that joke as an outlook on either companies’ products but, rather, as a suggestion for you to keep in mind as you are adding and removing options trades to or from your portfolio. That is, you should keep on top of your trades daily to make sure they’re still working, and to junk them if they’re not.
Sometimes trades break down and other times they rocket to the moon as though they were propelled by jet fuel. And if you find that a trade turns out to be a lemon, you can sell it back to its owner and test-drive something different that can turn out to be a much better investment!
As a savvy investor who may want to trade options on names that are in the news, remember that just as you don’t know how high a stock is going to trade, you also don’t know how far it can fall.
Accordingly, there is no one-size-fits-all approach to trading options — and thank goodness, because for as many directions as a stock can trade, there are dozens of ways you can trade options to capture these moves and leverage them to your benefit!
While we primarily buy options to speculate on a quick, sharp move up or down, options are a marvelous tool that can also be used to insure your stocks from downside losses by buying puts, and to generate income by selling covered calls.
The key to long-term success as an options speculator is to hit home runs. And the key to hitting home runs …
… is buying extremely cheap options like the positions that I recommend weekly in my Maximum Options trading service. I know that $2 might not buy much in the real world, but in the options market, it can go a long way in positioning you for big returns.
Cheap options have the potential for spectacular gains, and you won’t lose 25 years’ worth of profits in a few days with an option trade.
Still, this is a tough market, and no one — not even an options trader — is immune to this market chaos. You’ve got to be smart, savvy and you’ve got to follow the following three rules whether you’re trading my recommendations or venturing out on your own.
RULE NO. 1: WHETHER YOUR BIAS IS BULLISH OR BEARISH, YOUR PORTFOLIO NEEDS BALANCE
The market hasn’t exactly been very kind to investors in the past few days or, for that matter, in the past year. These types of conditions naturally lead traders to find more opportunities to short the market or individual stocks themselves (which we do much more safely by buying put options instead of selling shares short).
What I’m saying is that you can have a bearish outlook and load up on put options to profit from stock and market downside. But …
… you should always buy both calls and puts, no matter how badly things are looking “out there.”
Remember all of those rallies that have taken place in the broader indices as well as in strong stocks and sectors that simply remained unaffected by the overall market malaise. Remind yourself of all the rallies that have yet to happen. They’re coming … and you have to prepare for better days ahead, as the market always powers upward eventually.
RULE NO. 2: THE KEY TO MINIMIZING RISK IS NOT TO TAKE MUCH IN THE FIRST PLACE!
No doubt you’ve watched the nightly news or read about someone getting maimed or killed by doing some kind of crazy stunt that put themselves in jeopardy. You shake your head and think how you would never have tried that — are they crazy?
If you wouldn’t get on a flying trapeze without having a safety net below you ‘just in case,’ then you definitely wouldn’t want to take on unnecessary risk in your investing, trading or especially your options trading. That is, you wouldn’t put all your money into one opportunity on the false expectation that it’s going to skyrocket in value and that you can hand your boss a resignation letter on one trade alone.
Bottom line, don’t put all your eggs in one basket because if the trade cracks, you’ve got the makings of a big omelet.
Instead, in addition to establishing different types of positions (as I noted above with buying calls and puts), but also having a selection of both, in different sectors and, at the very least, different stocks.
In this market, I know many people feel that minimizing risk isn’t possible, but don’t make that mistake. Pay as little as possible for each option and …
… always be ready to cut your losses. Remember that for your long portfolio, too.
RULE NO. 3: PATIENCE REALLY IS A VIRTUE, AND GREED ISN’T ALWAYS GOOD
Options move quickly — this volatility is one of the main reasons I like them so much — but the current wild market swings can take you out of some positions before you reach full profitability.
Because options move quickly, you can find that your trade moves deep in-the-money in the blink of an eye. Conversely, it can turn against you just as quickly.
Keep that in mind when you’re sitting on a profitable position. You may want to keep it open for as long as possible to capture as many gains as possible. This is understandable, but there are ways to do it right.
You may buy a certain number of contracts when you enter a trade, but you don’t have to close the entire trade at once. You can edge out of a position incrementally, selling a couple of contracts here or there to lighten up your risk. If a position becomes profitable, by all means, you should feel free to bank some profits.
Allowing the remainder of your contracts to ride in case of even more upside is a great way to squeeze as many gains as you can out of a profitable trade. But if you leave everything on the table …
… and something happens to send the stock in the wrong direction, your previously impressive gain can turn into a painful loss.
BONUS: 6 TIPS FOR BUYING THE BEST OPTIONS
The above advice can help you weather this market and even profit from it, but in this environment where every financial pundit has a different opinion, it can be difficult to cut through the chatter.
That’s why I want to give you six specific tips for surviving this market and coming out the other side with a fistful of profit.
1. Plan before you play. You need to have a game plan that tells you when to take profits and when to cut losses.
2. Maximize your leverage. Try to buy options that will increase in value by at least 100%. That’s my built-in goal for every recommendation.
3. Buy options on high-volatility stocks. As options traders, we have a limited amount of time to work with. Use the high-volatility of the underlying stock to propel the position.
4. In general, buy out-of-the-money options. These options normally have lower prices, and therefore less risk.
5. Buy undervalued options whenever possible. I’ve done this for more than 35 years, and it still works.
6. Be patient. This rule is the most important. Contrary to popular belief, buying speculative options is not a game that requires action every day.
Successful options buying requires patience and selectivity. It is the only way to win this game, and win the game we will … again and again!
If you enjoyed this article, check out Ken Trester’s “Big Names, Big Profits?” and “4 Factors in Play with Options Trades.”
