Managing Risk With Options by Scott H. Fullman
Ever get the feeling you're throwing good money after bad in your stock transactions? Ever feel your wallet getting lighter and lighter while it's still in your pocket because of what your stock's doing? Ever feel like selling it all and getting out of the market altogether? Well, fear not. Author and derivatives strategist Scott Fullman explains how to keep your wallet in place by using options.
Imagine this scenario: You're going on a road trip, so your mechanic checks the car out to the tune of
$550 to make sure it's in working order. But traveling down the freeway, you are shocked to see smoke
rising from under the hood of the car. You manage to get to a service station, where you find that your
water pump has failed. Two hours and $400 later, you're back on the road. You can't help but wonder:
Should you keep putting more money into this car, or buy a new one?
CHECKING UNDER THE HOOD
Many investors and traders suffer from the same type of situation when it comes to stocks. For example,
assume that you purchased 1,000 shares of Eastman Kodak (EK) at the equivalent of $49 per share (prices
adjusted for the spin-off of Eastman Chemical [EMN]) on November 18, 1993 (Figure 1). Technically, the
chart looked positive with a move up from 40 in August 1993. Being a savvy investor, you immediately
enter a stop-limit order to sell the shares at 47-3/8. On December 14, EK opens at 47-1/8, a gap opening
from the previous close of 49-3/16. Your stop-limit order was not executed, and the stock continued to
decline into January 1994 (Figure 2).