Sane Bull US Indexes

Friday, July 24, 2009

What About Risk?

Risk (and risk management) is one of the most important topics to any trader, and most investors.
We have seen that buy and hold can be just as risky, (and scary) as any other method of investing. There are very few risk free investment vehicles out there. (A complex options strategy using long stock, a long put and then some other options strategies can be made risk free, but it takes active management and some luck.) We all know someone who has lost it all in ...... insert your favorite investment vehicle. (Real Estate, Stock Market, the Lotto, etc.)

The specific risks here are:
  • The stock. In any covered call the motto to remember is: "the risk is in the stock." The stock could go to zero causing you to lose all the money invested.
  • Loss of upside. This method will rarely produce a gain of more than 10%.
  • The stock! This is the #1 risk, that cannot be over emphasized!
Anyone trading options should read: Characteristics and Risks of Standardized Options from the Options Clearing Corp.

Now, one reason I do in the money covered calls is I get immediate downside protection. If as in the previous post, I spend 5.56 (including my received options premium) for a stock trading at 6.25 with the obligation to sell at 6.00, my stock of choice can drop 0.25 before I don't make my maximum gain and it can drop .75 before I lose money on the whole position. (I have had it happen though..... it can be nerve wracking!)
Of course, if the stock rises to 7, I still only sell for 6, hence the loss of upside, but I give that up for predictability!

All said, this is not for everyone, there will be few home runs and some nail biters, but it is a consistent way to make money!

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