Stock Picking, Short Selling and Put Options

Stock picking is not easy.  Sure you can make money picking stocks.  But the real question is can you do better than simply buying a low cost index ETF?  Most investors can’t.  Picking stocks to short-sell is even tougher.  To execute a short-sale you pick a stock that you think will go down.  Then you sell it with the idea of buying it back later at a lower price.

The problem with short-selling is the added risk when you are wrong.  When you buy a stock the most you can lose is the amount you invested.  But if you short the wrong stock you can lose a lot more than your initial investment.  The short-seller’s nightmare is shorting a stock that soars 100%, 200%, 300% and more. When you buy a stock worst case is it drops 100%.

Buying a put option is an alternative to short-selling.  When you buy a put option you can profit when a stock drops in price.  Better yet, your risk is limited to the amount of your investment.  You can also buy puts on a stock index or ETF that will profit if the overall market declines.

The table below shows an actual series of recently executed long put trades on Seagate (STX), Western Digital (WDC) and SPDR S&P 500 ETF (SPY).

real world option trades

In rows number 2, 3 and 4, we see a series of net losing trades in five long STX puts options.  Here the total investment was about $330 and the realized loss was $175.06 or -48.5%.  The loss would have been 100% except one option contract was sold at a profit as shown in row number 3. Four of five put options purchased fell to $0, expiring out of the money, worthless.  It’s easy to lose money trading options.

In rows number 6 thru 12, we see a series of highly profitable trades in five STX put options. Here a $502.46 investment yields a net profit of $3,283 over a twelve day period.  That was a rather impressive 653% return on investment!  This demonstrates the allure and profit potential of coupling the right stock pick with the right option.

In rows 16 thru 23, we see a similar series of trades in puts on WDC also yielding a nice profit. The thesis for both trades was WDC and STX stock were overvalued and set to fall due to plunging memory and hard drive prices.

In rows 26 and 27 we see a purchase and then sale of five puts on the SPY.  This trade netted an 83% return in 15 days.  Buying put options on index ETFs can be good tactic to hedge your stock portfolio in the event of an overall market decline.

Call Successful Portfolios at (727) 744-4818 for help on how to pick stocks, trade options and hedge your portfolio with put options.  Prior to buying or selling an option, investors should read Characteristics & Risks of Standardized Options, the options disclosure document (ODD). Don’t assume that option trades you make in the future will be profitable or will equal the performance of the trades shown in the table above. Stock picking and market timing is harder than it looks. The information presented herein is for educational purposes only and is not intended to be representative of the overall performance of Successful Portfolios recommendations and client accounts.

About the Author:

Parker Evans, CFA, CFP, CMT is President of Successful Portfolios LLC, an SEC Registered Investment Advisor Firm based in Clearwater, FL. Parker helps individuals, families, and organizations plan and manage custom investment portfolios at leading brokerages including Charles Schwab, TD Ameritrade, and Interactive Brokers.