In todays markets, everyone from amateurs to professionals
alike experience losses in their option stock picks. Since the
bubble burst, investors have come to understand that managing
losses is just as important as attaining profits.
We have all found ourselves in situations where we have purchased
option stock picks
that proceeded to trade down leaving us with
a loss or a losing position that we had to fix.
During the recent bull market, a common solution was to buy
more of the option stock picks at their lower price and wait
for them to go up. This strategy of buying more option stock
picks is called doubling down. This is a risky strategy and
not what we recommend, but lets review it anyway.
Doubling down allows investors to lower their dollar cost per
share so that the option stock picks only has to gain back a
portion of the loss to reach break even.
For example, let's say you purchased 500 shares of XYZ option
stock picks (XYZ) for $40.00 per share. Your capital layout
would be $20,000. (Commission costs, which vary greatly, are
not included in our calculations of option stock picks transactions
but should be included when you figure your bottom line.)
Now lets suppose that the option stock picks immediately dropped
down to $30.00 per share. You would have a $5,000 loss on your
investment. In order for you to recoup your $5,000 loss, the
option stock picks would have to trade back to $40.00.
The doubling down strategy would have you buy another 500 option
stock picks at $30.00 which would give you a total of 1000 option
stock picks. (500 shares purchased at $40.00 and another 500
shares at $30.00). This would produce an average purchase price
of $35.00 per share on 1000 shares, and is known as dollar
With the option stock picks at $30.00, you are now only $5.00
away from being even instead of $10.00 away. This is because
you now own 1000 shares at an average price of $35.00. With
this position, the option stock picks would only have to trade
back up to $35.00 for you to break even instead of the option
having to trade all the way back to $40.00.
However, if the option stock picks did trade back up to $40.00,
you would see a profit of $5.00 per share on 1000 shares, for
a $5,000 profit.
This strategy worked very well during the bull market and for
years, many investors made large sums of money buying the dips
and doubling down.
In the table below, lets assume that we purchased the option
stock picks at $40, as in our example above, and then purchased
additional shares at the new stock price.
When the bubble burst, the greatest weakness of this strategy
was exposed. When you double down, you are doubling your position
to average down your dollar cost per share. However, along with
the doubling of your position comes the doubling of your risk.
The strategy works well when your option stock picks rebound,
but not so well if the option stock picks price continues going
Once the bubble burst, many investors not only felt the sting
of not being able to recoup their initial loss, but got hit
with additional losses after they "doubled down" and their option
stock picks continued to trade down.
Let's look back at our example. Above, we purchased 500 shares
of XYZ for $40.00 and the option stock picks traded down to
$30.00 leaving us with a $5,000 loss. We then purchased 500
more option stock picks in a double down strategy to lower our
average cost. We now own 1000 shares at an average cost of $35.00.
Now lets say that instead of the option stock picks
the stock continues to fall to $25.00. The original purchase
of XYZ at $40.00 has netted us a $15.00 per share loss for a
total dollar loss of $7,500. But we also have to account for
the additional 500 shares we bought at $30.00. This amounts
to a $5.00 per share loss on 500 shares for an additional loss
of $2,500. This brings our total loss to $10,000!
As you can see, doubling down doubles your position both on
the way up and on the way down. It can help eradicate losses
but can just as quickly multiply them.
So what can an investor do?
Introducing the Amazing Stock Repair Strategy. This strategy
involves buying one at-the-money call option while simultaneously
selling two out-of-the-money call options on the same stock,
in the same month.