Welcome back to my weekly column with International Business Times brought to you by Optiontradingpedia.com.
One set of numbers came up out of the mouths of traders more than their own birth dates this past week; 10,000 points. Indeed, the 10,000 points level is predicted to be an extremely strong resistance level as some analysts name it the dividing line between a recession market and a growing market. Indeed, the Dow challenged the 10,000 points level twice last week but failed to stage a decisive breakout. Internals were weak as traders take profit across the board, dragging strong stocks and driving down weak stocks further.
One of those very weak stocks is Amag Pharmaceuticals Inc. trading under the symbol of AMAG.
AMAG Pharma is a company whose main line is a therapeutic agent known as Feraheme. AMAG has been hit by a string of downgrades last week with analyst Eun Yang citing Feraheme appears to have only modest sales potential among patients on dialysis. That would hurt its sales and delay profitability for AMAG.
AMAG's stocks has been under pressure since May 2009, going into a neutral trend til July 2009 before going into a bear trend coming from a high of $60 to close $35.51 last Friday. So, what can you do if you expect AMAG to continue moving down without having to short the stock and also limit your exposure in case AMAG should breakout with a possible breakout of the Dow over the 10,000 points level?
The answer is to buy Put Options.
Put options are contracts that allows you to sell the underlying stock at a fixed price no matter what price it may be in future. As such, put options rise in value as the underlying stock goes downwards! That's right, you can profit from a drop in the price of a stock without shorting the stock and locking up a big amount of cash in your trading account! Put options also limit your risk and exposure to the amount of money that you used towards the purchase of the put options. Nothing more. These characteristics allows you to profit if AMAG continues to drop in price but also limit your risk to a predetermined amount should AMAG should stage a sudden rally when the overall market breaks out.
If you are expecting AMAG stocks to go down for a few months more before finding a bottom, buying AMAG's put options expiring in January 2010 may be good enough. Since we are expecting AMAG's price to go down, buying AMAG's put options at the $35 strike price may be reasonable. So, we have our candidate: AMAG's January 2010 $35 strike price put options which closed at $3.90 last Friday. Instead of locking up more than $35,000 by shorting 1000 shares of AMAG, you could control the profits of those same 1000 shares of AMAG by paying only $3900 through buying 10 contracts of its put options! This sets your maximum risk for this position at only $3900.
This put option gives you the right to buy AMAG shares for $35 no matter what price it is in future. If AMAG drops to $25 by expiration, the put options will be worth $10 as it allows you to buy the stock $10 cheaper than the market price. By then, if you simply sell the put options, you would have made a profit of $10000 - $3900 = $6100 out of your initial commitment of $3900! A return of almost 100%!
Read more about Put Options by Optiontradingpedia.com.
Disclaimer : Neither I nor Masters 'O' Equity or Optiontradingpedia.com and any of the staff, own any shares in the above mentioned options trading position. The above article uses closing prices on 9 Oct 2009. Actual prices on Monday opening may differ. This article is for education purpose only and should not be taken as individual investment recommendation. Options trading is not suitable for everyone and advise should be sought from your local financial adviser.