If you have been following our blog, you may remember a few articles from the archive discussing risk-reward ratios and knowing the risks involved with the company before you place a trade.
April 24th, 2006 – “Stock Market Research”
July 21st, 2006 – “Learn the Risk Factors and Profit”
September 14th, 2006 – “Company Earnings and Stock Options Straddle”
The highest potential rewards in stock and options trading also carry the highest potential risks. Naturally these types of trades appeal to the risk taker in all of us. We are in the market to make money, so why shouldn’t we take the risk to make the most money?
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When we walk into a casino we are not interested in the quiet tables. We are drawn to the actively raucous tables. We want to be part of that revelry, joining the crowd having so much fun and obviously making lots of money, otherwise, why would they all be at that one table? We’ll step up to the wild table and roll the dice, bet on red instead of black, play the inside instead of the outside joining the others in speculation. We’ll place our bet then look to the heavens reverently and kiss our lucky charms awaiting the bounty of one lucky turn. We don’t care what has happened before we got there, which number has come up the most on the dice or the wheel, we simply want in on the current trend hoping to make a quick buck without research…
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How dangerous these gambles can be. In early morning trading, investors were reminded of these risks and the potential rewards of this type of speculation. Of course, we are talking about biotech stocks…
Loser:
First, AtheroGenics (AGIX). For over a month the potential gains on stock options trading seemed to good to be true. Both call options and put options had implied volatilities well above 200% causing option premiums to be greatly inflated, and naturally the volume on those options was high as every speculator rushed to the loud table.
Why were the premiums for AGIX so high? Because of the risks involved. AGIX had an experimental drug in FDA Phase III trial. If the drug passed the trial, AGIX could sky rocket. If it failed, AGIX would crash.
Recently, an investor could have purchased shares of AGIX for $7.83 and sell an April 10 strike call against those shares (Out-of-the-money Covered Call trade) and collect $3.50 per share.
Yes, that’s a potential 130% return if they were assigned with a 45% Downside Protection. Look at that return! How could one go wrong?
But then AGIX announced that the experimental drug did not meet the trial goal. Shares plunged to $3.22 losing over 50% of their value. The implied volatility that had caused so many to yell and scream with speculation had now disappeared and the option premiums dried up.
Craps. Clear the chips off the table. All the money goes to the house.
Winner:
In contrast, a similar trade could have been made on Acadia Pharm. Inc. (ACAD). An investor could purchase shares of ACAD for $6.69 and sell an April 7.5 strike call against those shares (Out-of-the-money Covered Call trade) and collect $0.55 per share. This covered call trade had a potential 22% return if assigned while still having an 8% downside protection.
But then, ACAD’s drug passed it’s mid phase trial. Shares of ACAD rose over 100% and are currently trading around $13.50.
Red or Black:
Sure, potentially large profits could have been made on both AGIX and ACAD if the investor guessed the right direction. However, without proper research this type of trading can lead to large losses. Step up to the most active table. Red or black, Sir? Inside or outside, Madame?
Though it is difficult to know what company may pass or fail a trial phase test, the tools on PowerOptions have been helping investors find, compare, analyze and research option positions for 10 years. Using the patented suite of tools on PowerOptions investors are able to filter out the riskier positions to find only those trades that match their risk reward tolerance. Stable and steady stocks may cause fits for the risk taker that lies within all of us, but our portfolios might be in better shape for doing our due diligence research and avoiding the loud table.
For more information about how to identify and research great option trades, visit the PowerOptions website. There you will find the data you need to make quick, clear, and informed decisions. You can trade knowing you have found the best investment. Also, PowerOptions will allow you, with a few quick clicks, to quickly and accurately compare trades. PowerOptions‘ premium customer support is second to none in the industry. They can be easily contacted when you need them at their toll-free number to answer customer questions. Call them now toll free at 877-992-7971.
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PowerOptions‘ sister company PowerOptionsApplied provides expert stock option trading recommendations. PowerOptionsApplied specializes in covered calls, naked puts and iron condor stock options strategy recommendations. PowerOptionsApplied provides a 30-day risk free trial of its service.
[tags] FDA, ACAD, Acadia Pharm. Inc., AGIX, AtheroGenics Inc., covered call investment strategy, implied volatility, investment strategy, iron condor, options trading, poweroptions, stock option trading, stock options [/tags]