How to Minimize Risk and Still Take Advantage of a Price Rise
If you own Tesla Motors, Inc. (NASDAQ: TSLA) and bought this momentum stock at much lower prices, then congratulations to you! Nice job on the great profits.
Now you need to do the right thing and look at an exit strategy, according to my stock analysis. Yes, Tesla could easily move higher. In fact, Northland Capital Partners recently increased its price target from $95.00 to $230.00 on Tesla, up about 67% from the close of last Friday. That’s great, but there’s also a $38.00 target on Tesla, according to Thomson Financial. This is clearly too low, based on my stock analysis. The mean target was $120.55 as of last Friday. What I would do at this time is take some profits off the table, based on my stock analysis.
Some of you will look at the $230.00 target and say my stock analysis is incorrect. Hey, I might be wrong, and it wouldn’t be the first time, but I have been able to survive for over 20 years of trading and not lose my capital base because I knew there were times that profits had to be taken.
This is a mistake made by many investors who believe in the high targets flown around by Wall Street. Guess what, these targets are usually never on the mark, based on my stock analysis. If you bought at much lower prices, take some profits as in “buy low and sell high.” This makes sense.
Now some of you are probably also buying Tesla at the current high point. This is not what I would do. I really don’t adhere to the “buy high and sell higher” strategy.
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I would rather place a price limit order to buy on a stock correction in the case of Tesla and other high-priced stocks—that would make more sense, based on my stock analysis.
For those of you familiar with options, a viable alternative that limits the total risk taken yet allows you to ride the gains higher is via the buying of call options, based on my stock analysis.
I’m going to use an example to show you how it works.
Say Tesla is at $138.00 and you feel the stock could pop up to $180.00 by December 21, 2013. Under this assumption, you can buy the out-of-the-money $150.00 call on Tesla priced at $16.80 per share or $1,680 for one contract, representing 100 shares of Tesla. This is your maximum risk.
Now say Tesla surges to $190.00 by the December expiry of the option. You would make $23.20 per share, or $2,320 per contract, or a return on investment of 138% in nearly five months.
The chart for Tesla is featured below:
Chart courtesy of www.StockCharts.com
But say the market reverses and Tesla falls to $100.00. You would lose the premium of $1,680 paid. However, if you had bought 100 shares of the stock, you would have lost $3,800, which is much worse than the call option strategy. At $100.00, you could always go in and buy positions.
The example I used here can be used with any stock that has made some rapid gains and you are interested in buying, based on my stock analysis.
This article How to Minimize Risk and Still Take Advantage of a Price Rise was originally published at Investment Contrarians
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