Sell Discipline
Sell Decisions
Trading stocks is a mentally tough game. No matter how long and hard we think through our decisions, we're likely to find our newly-bought stock trading lower. And our just-sold stock trading higher. When our egos and emotions start interfering with our decisions, we may completely freeze up. Or act recklessly, hoping to prove ourselves right.
We may be on the sidelines watching the stock we wanted surge higher daily. When we finally buy it, it craters. The stock gods see us coming and start playing their jokes.
Once we own a stock, if we sell too soon, we suffer seller's remorse. If we hold too long, we are the greater fool. One way to be free of the psychological drama of the sell decision is to determine in advance what percentage gain we'd be satisfied with during a specific period.
Good Till Cancelled
Placing a Good Till Cancelled (GTC) limit order to sell at our target price relieves us of having to make decisions while our brain's emotional centers are in control.
But even a GTC order can fail to serve its purpose. Usually because we cancel it. We watch our stock surge towards our target price and start worrying it will zoom right through without us. In a quick save, we cancel the order. Then the stock tanks. I've done this often enough to know that pulling my GTC order usually leads to second-guesser's regret.
Discipline
Discipline – having and following a plan – doesn't guarantee less short-term timing mistakes. But it does minimize the gravity of mistakes once made. Discipline forces us to adhere to our reasoning instead of making emotional decisions. At the onset, we picked a stock believing it would go higher. If our decision was based on fundamental factors, then we should have an exit point based on the same calculations.
Rule 1: Have a plan.
Rule 2: Follow your plan.
Rule 3: When tempted to abandon plan, see Rule 2.
Example
Suppose you bought 100 shares of Apple (AAPL) just days ago when it was at $400. You have about an 11% gain as of April 30, 13.
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Your plan could be to set a GTC limit sell order at a price at which you think AAPL is no longer a compelling buy. What price is that? Whatever strategy you used to determine that AAPL was a value at $400 could be applied to determine the price at which you think it is too rich.
Alternatively, you could consider writing (selling) one June 2013 $490 strike price covered call. That option traded at $3.40 per contract with AAPL @ $442.55 yesterday (April 30, 13).
If AAPL closes above $490 on Friday, June 21, you will be forced to sell 100 shares at $490. Your net sales price, if the call is "called," would be $490.00 + $3.40 = $494.40 per share. That is 23.6% above the $400 purchase price. It is also $51.85 /share higher than April's last closing quote.
Apple’s near term ex-dividend date is a side benefit for option sellers. Owners of AAPL will qualify for the next $3.05 per share dividend just eight days from now.
It would be absurd for holders of the June $490 calls to exercise them early to “steal” that dividend payment. AAPL, north of $490 by May 8, would require anyone exercising those $490 calls to come up with $49,000 in cash to capture a$305 distribution. Anyone wanting that dividend would have bought a shorter-term call, for much less money, than the June strike date calls.
Here’s a tabular view of how the possible covered call scenarios could play out from the April 30, 2013 close @ $442.55.
Buyers on April 24 at $400 could see a setback of $6.45 per share from the April 30, 2013 price and still be ahead by almost 11% from trade inception. Including the call premium and the May 9 dividend they could absorb a drop to as low as $393.55 without suffering a net loss.
The key concept here is to pick a percentage gain where you are willing to sell and stick with it. Don’t even think about buying back the shares if the call goes into-the-money. Let market action determine when to let go of your shares.
Placing covered calls above the market might have saved a lot of grief for Apple investors over the past six months. Anyone with shares called away could have bought stock back cheaper on numerous occasions.
The lather, rinse, repeat cycle makes a great plan.
Stop worrying about missing potentially larger upside. Let covered calls lead to selling shares automatically while taking the emotion out of your decision-making. Your net worth will be better off for it.
