When Your Favorite Stock Tanks, Consider Trying This

TheStreet

If one of your darlings has hung you out to dry, you don’t have to just take it.

Investment has lots of lessons to teach, and high on the list is this: No strategy is foolproof. No matter how well you’ve read the fundamentals, or how cleverly you manipulate the chart, things can go wrong. 

That’s what happened recently with Real Money Columnist Paul Price’s position in a stock that he felt particularly good about.

“Theory is great. Real life trading, though, throws plenty of monkey wrenches into even the most beautifully thought out plans,” Price wrote recently on Real Money. “That was certainly the case when Qurate Retail  (QRTEA) – Get Qurate Retail, Inc. Class A Report, one of my favorite holdings, tanked badly on Jan. 28. Shares that had been in the mid-$11s less than three months earlier were knocked briefly to an intraday low of just $5.75. Ouch.”

In a situation like this, clever traders often reach for the covered call.

“I noticed on Wednesday that there were eager buyers of QRTEA’s Jan. 20, 2023 expiration date $12.25 strike price calls,” Price wrote.  “As such I was able to parcel out 220 contracts, representing 22,000 of my QRTEA shares, at $0.45. It took 21 separate transactions to do so without tanking the option price or exhausting the call buyer’s demand [and generated almost $10,000 in contract premiums].”  

(Calls give the purchaser the right to “call” the stock from the seller at the underlying strike price, in this case $12.25.)

“What did I give up by selling these calls?” Price asked. “I capped my maximum upside between now and expiration day (Jan. 20, 2023) at $12.70 (the strike price plus the call premium per share).”

He added, “the covered call is when you sell call contracts for stocks that you either already own or intend to buy. This creates “cover” for your position. The traditional downside of selling a call contract is that you might have to go out and buy a series of stocks, then sell them for less than you paid and take a loss. In a covered call, you don’t have that risk because you already do or will own those assets.”

As a result, “the premiums that you collect from selling your call contracts generate income. If your existing position goes bad, that income can offset your losses. If it does well, you might end up capping your gains, but you still get to sell the stocks for another round of gains.”

Get more trading strategies and investing insights from the contributors on Real Money.

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