27 April 2007 – Well today, when BIDU gapped up over 19% to $130 a share, I closed out the remaining BIDU May 100 Calls at 400% profits. Yesterday I took a little bit more off the table at 85% profits, and as you recall, I initially took 50% off the table at 50% profits. Not bad for less than 14 days, right?
Now initially I had a gut feeling that BIDU was going to announce record earnings but gut feelings do not constitute a low risk- high reward investment opportunity. The extremely sharp, rapid decline of 30% in share price and the floor that formed around $98 a share is what set up the low risk-high reward play. I know that there are people out there that will say, “Well you would have made so much more money if you had let the full position ride until today before cashing out,” but this is where the second lesson comes in.
You should NEVER feel bad about taking 50% and 85% profits off the table when it comes to option plays, especially since options can turn on a dime and all profits can be wiped out in a single trading session. Do I wish I would have let the entire position ride until today so I could have made 400% profits on my entire position? Sure. Do I regret it? Not at all. And even so, there will still be others that say, with the positive earnings release of yesterday, that maybe BIDU will reach $140 by next week and that I should not have sold out today. But not taking 400% profits is just plain foolish.
By the way, even if you got in late on the BIDU May 100 Calls based upon our post, there was still plenty of time after our post to buy in to these options when BIDU traded at only slightly above 100 a share. If you made 200% to 300% profits in a couple of days because of our blog post, we’d love to hear about it, so please drop us a note. And this brings me to lesson three. If you start basing your decisions on hopes and dreams, that is all that is necessary to turn a low risk- high reward proposition into a high risk-potentially high loss proposition. Yes, emotion alone can change a very good set-up into a terrible outcome.
This brings us to GM. GM hasn’t fared so well but I still believe the outcome will be favorable. !!GM@@ However, I still always set my stop losses on option plays between 35% to 45%. So if they hit this range, I will sell out no matter what and cut my losses. Today, GM dipped below its 50 day SMA again before breaking back to the upside, so there still is a strong possibility this play may turn out well. But the method in which this play is developing provides me with a prime example of what gets a lot of investors into trouble. Since I purchased the June 25 puts over the course of a couple of days my average price was actually slightly less than the $1.30 per contract I stated in the previous blog at $1.26. Since the BIDU plays turned out so well, I’ve decided to widen my stop loss position for the GM plays to 40%, so if these puts dropped to $0.75 a contract I would sell out and cut my losses.
When GM spiked much higher yesterday, many investors in my position in these puts would have doubled down, telling themselves that if they bought the contracts at $1.26, then $0.90 a contract must be a bargain. Of course, the psychology that leads to such behavior is the infallible mindset of the retail investor. “Surely, I must be right”, the retail investor thinks, so this is nothing more than a buying opportunity while the idiots have the situation pegged all wrong. Of course doubling down your position, just changed the whole risk scenario of this investment opportunity as you have potentially doubled not only your gains, but also your losses. NEVER EVER fall into this trap. Keep your discipline and remember that sometimes, despite every clue that tells you a stock should behave one way, the market is still the decider and sometimes will render decisions that go against your best judgment.
This being the case, I just sat tight despite the temptation to add to my GM June 25 puts position. And still, even though I believe GM should head down and believed that a good risk-reward set-up existed in the put play, if the options hit my stop loss point, I’ll sell out without a second thought.
These are good rules to live by even in the world of long stock positions.
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J.S. Kim is the founder and Managing Director of maalamalama, a comprehensive online investment course that uses novel, proprietary advanced wealth planning techniques and the long tail of investing to identify low-risk, high-reward investment opportunities that seek to yield 25% or greater annual returns.
