I was asked about using options when shares aren’t available to short.  The fact that you were trying to short it in the first place says you aren’t looking to leverage it to the max.  In that case, typically buying a straight in-the-money put will match your needs the best.  Just buy one that’s not too far out so that you have a high delta, meaning that the option move more closely matches the stock move.  That way it’s closer to your original short position where you don’t have to worry about time.  You can consider bear spreads if the options are too expensive, but then you’ll have to figure out target prices and timelines. 

If you want to get in depth, you should get some options software.  Don’t worry, there’s a lot of free stuff out there.  Most brokers offer at least something.  The ones I’ve used, TD Ameritrade and Options Express have basic things that can help you compare the upside, downside, and timelines of the different options pretty easily.  You could also look at something like options oracle, which is also free.  Hope that helps.

The real answer requires a little more information, like where my stop loss is set.  Let’s look at the following breakout:

Regardless of where I enter the stock, my stop loss would probably be somewhere around $15.  Let’s look at 2 scenarios.  For the first, say I got a good entry of 1000 shares at $17.*  I’m risking $2 a share on 1000 shares, giving me a risk of $2000.  For the second, say I jumped on late and entered at $19, giving me a risk of $19-$15 on 1000 shares, or $4000.  Purchasing the same number of shares on the same stock, I risked twice the amount in the second scenario.

Most people will determine how many positions they want to hold, look at how much capital they have, and then just allocate an equal amount to each position.  For example, I want 4 positions, I have $100k, so I’ll put $100k / 4 = $25k in each position.  What you really want to do is set a constant risk across your positions though.

To even out my INTC scenarios, I would have to buy half the amount to get my risk back down to $2000 in the second case, or 500 shares.  But doesn’t that mean I’ll only make half as much money when it goes up?  Yes!  That’s why it’s important not to buy overextended stocks. Either your risk will go up or your reward will go down, and I think you know which way you want that scale to tip.

Once you get a grasp of risk sizing your positions, you’ll see that buying KO can be just as risky as buying some hot biotech company or even more risky than call options on a Chinese solar firm (risk is easy to determine on call options since it’s actually 100% of your investment). †   I’ll have more on this in a post about risk, reward, and capital in the future.  If the gap between my last educational post and this one is any indication though, don’t hold your breath waiting for it…

* Yes, I know this is a weekly chart and INTC actually gapped through this price.  Ignore the symbol and just look at the chart and numbers.

† This ignores the fact that stocks can gap down through your stop, but slippage is a topic for another post.

I remember the first time I read about covered calls, aka a buy-write, I thought it was the stupidest strategy.  Capped upside and unlimited downside don’t seem like a good combination.  Then I learned a little more about position sizing and how to set a constant risk amount so that you don’t just view risk as how much capital you put up to establish the position.  That made the unlimited downside part a little more manageable.

Recently I’ve been reading more about real estate (related to the fact that I need new investment ideas) and getting a much better grip on controlling cash flow.  With a far better grip of expectancy analysis over when I first learned about covered calls, they’re actually starting to seem interesting to me when viewed as cash flow.  After rereading chapter 2 in the McMillan options book as a refresher, I think I may start to dabble in this a little.  I don’t know if I’ll actually follow through on this, but it may add some different types of stocks that I look at in the future.

VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. A high value corresponds to a more volatile market and therefore more costly options, which can be used to defray risk from volatility.

The VIX can be used for a lot of things, but I usually use it as a complementary indicator to volume.  A declining VIX often means a consolidation period, and an increasing VIX often means an accumulation or distribution period.  You can find the chart for it here, but it’s available on pretty much every stock site.

How do you "really quantify your reasoning" though?  The easiest way is to write a blog!  I’ve said before that I would post on my blog even if nobody read it, and I actually mean it.  It doesn’t matter how well you write or what you end up saying.  The important thing is that you have to think about what to write.  Just trying to jot down a few sentences about a stock you like can be a very enlightening experience.  There have been numerous times that I liked a stock, sat down to write about it, and then realized that I really didn’t like it so much when I had to rationalize it in a public forum. 

It also works for things beyond just stocks.  Thinking about leaving your wife for the stripper down the street?  Go write that blog post first and see if you can come up with a solid appraisal of the situation.  If you end up with a well thought out 10,000 word post that backs your decision to leave, at least you know you’re making a conscious decision to do it.  Chances are though, once you sit down and are forced to formalize your arguments you’ll realize it’s a stupid thing and you would probably be embarrassed to have any of your reasons read by everyone you know. 

I also have a selfish reason for this tip.  I have a lot of friends who are very smart and know a lot about stocks, and I want to be able to see what they’re thinking too.  But even if you don’t want to make a public blog, a private journal can also do the trick.  You’ll be amazed at how much your opinion can change the first few times you try it.  And this doesn’t even go into the benefits of having a historical record of your thoughts, but that’s what I’ll be talking about next time.  So set forth, start your blog, and make sure you give me the address.

Also, since it’s just matching the daily movements of the index, over the long run that doesn’t quite work out due to compounding.  Say you started both funds at $100, one which is a double short of the other.  If the index goes up 1%, the double short goes down 2%.   After the first day, the index would be $101 and the ETF would be $98.  If the same thing happened a second day, the index would be $102.01 and the ETF would be $96.04.  Now let’s say the index goes back to $100 on a 1.97% drop; the ETF would go up 3.94% and end up at $99.82.  That’s minor right now, but over the long run it will end up not tracking the index as tightly as you may be hoping for. 

While not a disaster, it helps to understand why the S&P500 may go down 30% but SDS only goes up 50%.  Ideally, if you truly want two times the short exposure to an index, you would play the index futures or options so that you can manage your long term exposure a little more finely, but of course those have a whole other can of worms that go along with them.  Your 401k probably doesn’t have that option though, so knock yourself out with the short ETFs and watch your portfolio at least stay afloat while everyone else is eating it.

For example, if I had $10k that I was putting into SH (1x short), I would instead put $5k into SDS (2x short) + $5k into a safe investment, or $3.3k into BGZ (3x short) + $6.7k into the safe investment.  The numbers today show that the results of the ETF parts would have been SH +5.78% (+$578), SDS +11.22% (+$561), or BGZ +16.98% (+$565).  Depending upon how lucrative the "safe" part is, it could be a good idea to have other investments while still hedging the same amount.  Note, SH and SDS are S&P 500 ETFs while BGZ is a Russell 1000 ETF triple short, but this was just a general idea of how to split your money and why these aren’t just for the crazies. 

After a big event, like a basketball game or a concert, there’s always a flood of people rushing out to the parking lots.  Sometimes there’s a quicker, backdoor way to get out, but if you’re too far downstream it’s pretty much impossible for you to get there.  Even though you know it’s better, it would be futile to attempt it, so your only options are to follow the masses slowly meandering out the main door, or wait for it to clear out a little before heading for your unknown shortcut.

I constantly bring up the point that you should be trading with momentum, rather than against it, and this is exactly why.  Think about what actually makes stocks move.  While good earnings and balance sheets make a stock worth more intrinsically, that does not necessarily make the stock price go up.  What does drive the price up is people wanting to buy more shares than are currently being sold.

Maybe you noticed an underlying company that is good, but the majority of the people are going the other direction and selling.  People sell their shares of stock for a variety of reasons, and if you’re reading this blog you probably aren’t in a position where your buying a stock against the trend would make a significant number reconsider.  If the large majority of the people are going against it and making the stock go down, the only options you should consider are shorting it or better yet, if it really is a good company, stand on the side until they clear out.  Who knows, maybe the thousands of people going in what you think is the wrong direction actually do know better.  Standing on the sidelines and waiting may not be exciting, but attempting to go against the crowd will just leave you trampled and broke.