Stock Repair Kit
About every six months or so we receive a question/concern about stocks that have gone down in value. It’s that time again. Oh, how I wish our subscribers would really study PAID TO TRADE.
Mentioned were XOMA,REXX, AMD. Not mentioned were T, BAC (Bank of America)—which we traded when it was $6 to $9, and is now in the high teens—and a host of other stocks that are way up since we used them as covered call stocks. This is to be expected.
Let me make two general comments, and then I’ll add some specific things that can be done to help bail out of the problem,
- One of the inherent problems with writing covered calls is that over the long run—if we not very careful and weed the garden—we have a tendency to sell the good stocks and keep the dogs.
- Virtually every problem with writing covered calls—the main on being the stock going down in value—could be solved with effective stop-loss orders. More coming up.
Picking up with #2, let’s explore this. With XOMA we bought the stock around $4.50, but had a stop-loss at $3.60. Here are a few techniques to help you stay out of trouble generally, and help somewhat if you do get into trouble with a particular stock.
- Really research your stock purchases. When we say do your homework, here is what we mean. Make sure you check trade suitability with your broker. We are trying ourselves to find better stocks. We’ve been on the bad side of these trades too many times. We, too are doing better homework. Our trades should be one factor, not all of the factors.
- Find stocks with a high likelihood of going up.
- Set your stop-loss orders. Review the three ways to do this, meaning the stop-loss sell points. Briefly, a. many people use the 10% method. b. Others place the stop-loss sell point at the purchase price of the stock minus the option premium received. c. Some use charts to look for soft support and hard support. They place the stop-loss order at or near hard support.
- Monitor the story line of the stock. These stocks have a certain life for writing covered calls. The longest one I’ve had went 13 months. Now, don’t get me wrong, I’ve used some stocks on and off for over 15 years (AMD, MU, TASR, even QUAL, and NFLX). I’ve been writing covered calls for about 30 years. A quick point on this. The
- The stock needs to become your friend—without getting too emotional. You need to know when earnings are, when the Board of Directors meets, what the competition on is doing, and what the sector is doing.
- Read the part in PAID TO TRADE about Harold, and how he continued to sell options on his stock, even though it was down several dollars. I realize this is tough with stocks that fall under a dollar, but all others usually provide some premiums and these can put cash back into your account. An $8 stock can generate a nice premium, even though you bought it at $11.
- Ascertain whether to hang on to a loser or redeploy your money into better trades. This is tough, and again, I frequently have this problems when stocks have shot up.