How do single-day stock gains of 40%, 50%, 75%, 100%, or even more sound? If you're anything like me, they sound pretty darn great.
Those kinds of gains happen almost every day, but the mainstream financial media would much rather focus on Facebook's 0.5% jump forward on some new VR breakthrough, or Alphabet's top line beat sending the stock up 2%, say.
Don't get me wrong; those are great single-day gains for large-cap companies - but the real single-day home runs usually come from micro- and small-cap companies - for instance, biotech companies that have just announced exciting news.
The news can include positive trial results, a partnership with a major pharma company, earnings that surprised the Street... Almost anything that catches traders by surprise can spur huge gains.
When these kinds of announcements occur, it's not uncommon to see shares gap up 50%, 75%, 100%, or more, overnight. Those are the kinds of gains that create unimaginable wealth - and very quickly, too.
But, as you can imagine, this story of riches can just as easily become a nightmare if the company releases unfavorable trial results.
When that happens, shares can easily drop 50%, 75%, or more in after-hours trading. Even prudent investors using protective stops will feel the sting because they won't be able to exit the trade until the market opens... after the damage is already done.
But I'm going to show one simple technique that will leave you free to target as many of those 100% one-day gainers as you can handle - and protect them once you've got them in the bag.
Here's how it works...
Insuring Your Biggest Gains Is Actually Simple
All you need to do is purchase just one accompanying "put option" for every 100 shares of the stock you own, which essentially guarantees your exit price - no matter what price the stock is trading.
Professional traders refer to this as "marrying" the put option to the stock. I just refer to it as "buying insurance."
Let's take a moment to look under the hood of this strategy - in five quick and easy steps.
Profit Insurance: Step No. 1
Let's assume we've identified a company that is scheduled to make an important announcement on a specific date. My favorite announcement is the release of data from a clinical trials program.
Once we have a company we're potentially interested in, it's time to buy some insurance.
Step No. 2
We're going to focus on put options with the nearest expiration date "after" the scheduled date for the upcoming announcement.
For instance, if company XYZ plans to release clinical trials results on Dec. 10, 2016, then we'll want to investigate put options with the first expiration after Dec. 10, 2016.
Just a quick side note: Typically, options expire on the third Friday of the month, but there is an increasing amount of companies that have "weekly" options. Just make sure to target an expiration that falls after the planned date of the announcement. Remember, the put option is insurance... and as insurance, it won't do us any good if it expires before the company announcement.
Step No. 3
After we've identified a suitable expiration date, we'll need to target the "strike" price.
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This is a matter of personal preference - and availability - so we're going to want to investigate a strike that represents a price we would be comfortable selling XYZ in the event the announcement disappoints the market.
Personally, I like to limit this trade to stocks that have options with strikes very near the current price. For instance, let's say XYZ is trading at $5.20. I'll consider buying the $5.00 put option. If XYZ is trading at $7.25, I'll consider the $7.00 strike. If XYZ is trading at $10.35, I'll consider the $10 strike. You get the picture.
The main thing we're looking for is a strike price that is very near the current price.
Another quick note: Not every stock is going to have a strike that is close enough for my personal risk tolerance. When that's the case, I just avoid the trade altogether. Remember, there's always another opportunity just around the corner.
For the purposes of this explanation, let's assume XYZ is trading at $5.20 and we've targeted the XYZ December 2016 $5 put option.
Step No. 4
Once we've identified the potential stock, the expiration, and the strike price, we want to spend a couple of minutes to investigate the premium, the option's price.
Just like car insurance, we have to pay for our insurance - our put option - so we want to make sure it's not too expensive.
What constitutes too expensive? That's also a personal preference, but generally I want to buy insurance that doesn't exceed 5% of the strike price. In this example, we would proceed with the trade if we could buy the put option for $0.25 or less (or $25, because options are generally priced in multiples of 100).
In this example, the $0.25 price (per share) we pay for the put option will be added to our overall cost, which means our total cost to enter the trade is $5.45 ($5.20 for the stock + $0.25 for the put option) per share - or $545 per 100 shares.
Just to reiterate: We'll be purchasing one XYZ December 2016 $5 put for every 100 shares of XYZ that we intend to own.
Step No. 5
This is the easiest step of all - just sit back and wait for the upcoming announcement.
If XYZ reports great results, the stock could be off to the races and we'll be darn happy we were smart enough to buy shares "ahead" of the announcement. At this point, we can just let the put option expire worthless, sort of like your car insurance at the end of an accident-free month.
On the other hand, if the results fall short, XYZ shares could gap down, say, 50%, to $2.60 in the after-hours - but we'll get to sell our shares for $5.00, no matter what, because we purchased the XYZ December 2016 $5 put.
Meanwhile, other investors would be staring a huge loss in the face.
Even with this kind of protective power, some investors will be put off by the additional cost associated with buying the put option insurance.
They shouldn't be.
After all, just like car insurance, no one throws up their hands in exasperation at the end of the month because they didn't get in a car wreck in order to justify paying for car insurance.
Like Sid said, the market's biggest gains come from tiny stocks that live way off Wall Street's radar... until they soar overnight to huge profits. The trick is to spot these companies in advance, and Sid has spent the past six months researching how to do just that. His findings show the average gain hit 366% in seven months. Click here to be among the first to see his startling new findings on Nov. 1.
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About the Author
Sid is the investment community's best-kept secret. Since 2009, he's served at Money Map Press as Director of Research, analyzing thousands of securities and profit opportunities for subscribers. He's an expert in identifying "alpha" potential in a wide variety of industries, but especially the small-cap sector, where he's discovered a pattern of profits that's almost foolproof.