Thursday, April 19, 2012

Risk Profiles $AAPL $NFLX arguments + $CMG 3,276.42


I saw a tweet yesterday that read "You can't risk $4.00 to make $4.00, you will go broke doing that."
At first glance it sounds smart but if you take another look, it makes little sense.

Anyone buying a stock as an investment is risking '$4 to make $4!'
In all practicality, they are risking $4 to make less than $4.  Consider this:
If I buy a stock say aapl at 600, my max dollars at risk are 600!
So, IF the stock doubles, then I can say that I risked $1 to make $1. How soon is aapl going to reach 1200?
I know what you are thinking: what are the chances of aapl going to 0? Not high but the chances are NOT zero! One thing we've learned in past 4years that ANYTHING can happen.
Just ask all owners of lehman, bear, kodak, fslr, bac, citi, gm, (yahoo  rimm HPQ once champs now chumps), etc.
So, realistically if you want to buy stocks as investments you have to accept that you are risking $4 to make less than $4. You may hit home runs on spec or you can luck out of grabbing a MSFT or FB from launch but those are scarce and won't be the norm!
You can have an opinion of how likely the stock is to double or go to zero BUT the math is absolute and the risk profile when buying a stock is:
*** risking the whole price paid for the stock today in the hopes that it appreciates over time. ***

I got hurt in the .com bust because I had nothing but stocks (no crazy tech stocks). It took me years to get back to even. Now I use options because I know exactly my dollars at risk AND the risks are smaller than owning the stock outright. Furthermore, mistakes can be correct immediately instead of having to wait years for recovery. Here is a real example w/NFLX:

When NFLX was THE momo stock of the year (2011), I sold a credit put spread (bullish) NFLX 10x at strikes 205/200. The width of the spread being $5 made my max dollars at risk $3.8 (took in 1.2 to put the trade on).
On sep 12th 2011 all was well. But, on Sep 15 stock opened about $35 down then tumbled more to land around 120.
I closed my spread for a $3792.49 loss (5221.47 premium paid to close - 1428.98 premium I collected) the trade was for 10x so 1000shares.
--> Had I owned the stock outright I would have lost 35k the first day AND if I didn't have the guts to sell the 1st day then my losses would have more than doubled since NFLX continued to fall to around 120.

More current examples $CMG $PCLN etc. They've been on a tear; I want to get involved but can't buy them up here so instead I sell put spreads and participate that way. Just today I sold May Iron condor (11x so 1100shares) in $CMG for 3276.42 (420/15 - 455/60). Here if the stock goes to 0 or 1,000,000 the max I can lose is 2,223.58. Meanwhile, I get to hang on to my premium that I collected today. So here I risk 2223.58 to make 3276.42 that is a risk/reward of <1 (0.68to be exact)!!! I can also say that I risk $1 to make $1.47. By-the-way I had no out of pocket expense for this trade and I didn't borrow anything to put it on. It is a cash-backed trade.

I have another post Called 'Why credit spreads w/ $aapl $nflx $pcln' check it out. It has this NFLX example and more.
Btw, I don't have a subscription service nor do I manage anyone's money other than my own..
If you like these posts spread the word+ folo @racernic (twitter and stocktwits). Also peruse rest of my posts including the sides to help finance the java (if you know what I mean ;-) there is some good stuff. I do these post for free and have no subscription pitches.

I am not recommending anyone follow any of these strategies as they are NOT trade recommendations. I only invest money I can afford to lose.