It’s not uncommon for a company to get in trouble and suffer for many quarters, or even years, before there are some improvements. As a result, when a company’s conditions deteriorate, the stock prices follow in the same direction—they decline.
There are many examples of companies that got into a downward spiral and their stock prices plummeted over time—consider companies like Blackberry (NASDAQ/BBRY), formerly Research in Motion Limited, losing its market share to competitors, and Bank of America Corporation (NYSE/BAC) being heavily involved in mortgages during the housing slump.
One way investors can take advantage of this situation is by shorting the stock—betting that the stock will continue to go down. Unfortunately, to do so, they will have to meet their broker’s initial margin requirement and so on and so forth.
Instead of shorting a stock, investors can make use of an option strategy called the “naked call.” By employing this strategy, investors can also generate income for their portfolio.
Essentially, a naked call is a bearish option strategy in which an investor sells/writes a call option without owning the underlying security. As a result, the investor receives the premium selling price of the option and promises to provide stock if the price reaches a certain strike price. Keep in mind, this option strategy should not be confused with a covered call—they both have very different characteristics, risks, and rewards.
How does a naked call work?
Suppose that stock of ABC Inc. is trading at $20.00, but the investor believes it will continue to decline. Instead of shorting the stock, he writes/sells call options expiring in May for $2.50 per … Read More
In anticipation of a major announcement, investors sometimes just buy or sell a stock that could see a significant move in price in either direction—upward or downward—based on the news. These investors end up losing their money if the stock goes against their intuition. For example, they assume earnings of a company to be good, but the firm ends up showing negative earnings growth, coupled with other horrific news.
With this said, earnings are not the only event which can cause stock
prices to soar in either direction. Other significant events, such as a
CEO stepping down, an investors meeting day, or a product launch,
can cause huge swings in a stock’s price as well.
How can you make money in this situation without risking a lot? You can consider using an option strategy called “straddle,” or “long straddle.”
In essence, when an investor uses the long straddle strategy, they purchase a call option and a put option for the same strike price and expiration date.
Consider the chart of Research In Motion Limited (NASDAQ/BBRY) and the scenario below. (Please note: the following information should not be construed as a specific buy recommendation; instead, it should be used as an example of the type of opportunity you should seek out.)
Chart courtesy of www.StockCharts.com
The company is going to report its corporate earnings on March 28. With its new products in the markets, there are some who believe Research in Motion (RIM) will provide excellent earnings. On the other hand, there are some who say the company doesn’t have much room to grow. As a result, investors are confused about … Read More