A key to weathering – and potentially profiting from – a market correction is planning and implementation.
6 Ways to Help Protect Profits and Minimize Losses
Perhaps nothing keeps traders up at night more often than trying to figure out how to protect their profits and limit their losses. And while we want to emphasize that no system is foolproof, let’s examine some of the trading tools and tactics you can use to potentially protect your portfolio.
- Limit order. A limit order allows you to sell a stock when it hits a target price. The target price can be based on the percentage gain from your entry point, or it can be based on a resistance level that the security has had a hard time breaking above.
- Stop order. A stop order triggers either a market order (stop-on-quote or trailing stop-on-quote or a limit order (stop-limit-on-quote). Traders often set a stop order price below a support level price, which, if breached, could lead to further losses. Stop orders are not guarantees, however. If a stock price drops (or gaps) significantly, you could end up selling for lower than you anticipated.
- Bracket order. A bracket order includes both upside (limit order) and downside (stop-on-quote or stop-limit-on-quote) selling prices. One way you can establish the trade using a one-cancels-other order type. This is essentially two separate orders linked together so that when one order executes, the second order will automatically cancel. You are effectively able to establish two selling prices on the same security.
- Covered calls. If you own shares of a security, you can sell a covered call on those securities to generate income that could either boost gains or offset losses. However, with a covered call you are obligated to sell your stock at a specified price, which would cap your gains. You also could lose money if your stock position declines by more than the cash received.
- Protective put. A put gives you the right to sell stock at a specific price prior to the expiration of the option. You might use this strategy if you’re concerned about the price falling for a security you own. However, the cost of the option could be more than the profit on the security.
- Collar. A collar strategy can be used if you want to establish upside and downside selling prices, and involves selling a covered call and buying a protective put. The cost of the put will be offset by the cash from selling the call, and you will have a guaranteed selling price for the life of the option. However, you have the same risks attached the buying the put and selling the call. In addition, you should consider the impact of transactions costs and spreads when using a collar strategy.
What’s Right for You?
What’s right for you depends on your level of comfort with the tactics and the risk you’re willing to take.
These tactics, by themselves, are not a trading plan, but they can be essential components to help turn your plan into action.
The content provided is for informational and/or educational purposes only. The information presented or discussed is not, and should not be considered, a recommendation or an offer of, or solicitation of an offer by, Scottrade or its affiliates to buy, sell or hold any security or other financial product, or an endorsement or affirmation of any specific investment strategy. You are fully responsible for your investment decisions. Your choice to engage in a particular investment or investment strategy should be based solely on your own research and evaluation of the risks involved, your financial circumstances, and your investment objectives. Scottrade, Inc. and its affiliates are not offering or providing, and will not offer or provide, any advice, opinion or recommendation of the suitability, value or profitability of any particular investment or investment strategy.
The covered call option strategy may help generate income and offer limited downside protection, but does not provide full downside protection and may limit profit potential.
A protective put strategy raises the breakeven on the underlying by the amount paid for by the put. If the underlying security stays above the strike price you can lose the entire premium upon expiration.
Options involve risk and are not suitable for all investors. Detailed information on our policies and the risks associated with options can be found in the Scottrade® Options Application and Agreement, Brokerage Account Agreement, by downloading the Characteristics and Risks of Standardized Options and Supplements (PDF) from The Options Clearing Corporation, or by requesting a copy by contacting Scottrade. Supporting documentation for any claims will be supplied upon request.
The collar option strategy may help protect profits and offer downside protection, but may also limit profit potential and incur additional commissions, fees and charges.
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