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Editor's Note: Investing in small caps can be risky. The slightest news could send shares soaring… or ignite a steep sell-off, leaving you in the red. With Sid's simple "insurance" trade, you can hedge against that volatility. It takes just five steps…
How do single-day stock gains of 40%, 50%, 75%, even 100% or 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 recent stories such as: FB jumps 14% on increased mobile revenue, GOOG rockets ahead 13% on higher top line, or TSLA up 8% on higher than expected sales of the Model S.
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-cap and small-cap companies – especially micro-cap and small-cap biotech companies that have just announced exciting news.
The news can include positive trials results, a partnership with a major pharma company, earnings that surprised the Street… basically almost anything that catches traders by surprise.
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.
What if I told you there was a simple way to target these 100% gains while at the same time guaranteeing that you avoid any catastrophic losses?
Sounds too good to be true, right?
In this case, though, it actually is true…
Protect Your Profits with These Simple Steps
All you need to do is purchase 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.
Step 1: Let's assume we've identified a company that is scheduled (on a specific date) to make an important announcement. My favorite announcement is the release of data from a clinical trials program.
Once we have the potential company we're interested in, it's time to buy some insurance.
Step 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 March 10, 2018, then we'll want to investigate put options with the first expiration after March 10, 2018.
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 occurs "after" the planned date of the announcement. Remember, the put option is insurance… it won't do us any good (as insurance) if it expires before the company announcement.
Step 3: After we've identified the appropriate expiration date, we'll need to target the "strike" price.
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.
BIG, FAST PROFITS: This one pick paid 100% in seven days, then 205% the next day, and 410% by the next week. You've got to see how it's done…
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. 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 March 2014 $5 Put" option.
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.
I've truly never practiced this method, many thanks for discussing it.