Be Careful of Mistakes! Don’t Let it Be an Option

October 07, 2010

One of the investments I occasionally employ is options.  If I believe a stock is going to go up or down in the short term I will purchase the “option” to buy or sell the stock at a certain price.  Now I never actually hold this option until it expires, I will sell it – hopefully at a gain.  So why am I telling all of you about what I do?  Because I want to highlight the importance of sticking to investment fundamentals and what can happen if you forget, even one time.

In the midst of the banking crisis I saw a company that I felt would benefit in the very short term as far as its stock price.  Based on that I purchased a call option, which if the stock price went up would allow me to get a nice return.  Well, one of the key fundamentals of investing is protecting the downside risk, or in this case if the stock price went down. The way I minimize my downside risk when I purchase options is by immediately placing an order to sell if my option price dips to a certain level.  Yes, I will take a loss but not as bad as losing my entire investment.

Well, the ONE TIME I didn’t place this sell order what do you think happened?  Sure enough on a Friday afternoon after the markets had closed, the news came out that this institution was being taken over.  Needless to say the option price Monday morning went south and I was left with my tail between my legs.

The lesson for me was that I can’t get sloppy with the fundamentals, if I had taken just another couple of minutes to put in a sell order, I could have minimized my loss.

But hey, nice to know that even the pros make mistakes, right?