Questcor Pharmaceuticals Inc (QCOR), Green Mountain Coffee Roasters Inc. (GMCR), Linn Energy LLC (LINE): How To Protect Against Every Investor’s Worst Nightmare

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There has been a lot of talk here lately at StreetAuthority about selling options.

And with good reason. When it’s done right, options can be one of the best ways to make money in the market we’ve ever seen. It’s no easy feat to generate “Instant Income” selling options, and there are no guarantees. But our trading expert Amber Hestla, a former military intelligence analyst, has an amazing track record (20 out of 20 winners so far) — raking in thousands of dollars for her subscribers.

Recently, readers of Amber’s Income Trader, StreetAuthority’s premium newsletter dedicated to generating income by safely selling options, made $83 in “Instant Income” from a $640 “down payment” on Questcor Pharmaceuticals Inc (NASDAQ:QCOR). That’s a quick return of 13% in 30 days, or 157.8% a year.

And back in May, subscribers collected $90 in “Instant Income” from Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) — a company that doesn’t even pay dividends — for every $820 they set aside. That’s an 11% return in 44 days, or 91% a year.
Green Mountain Coffee Roasters Inc. (GMCR)Remember, this is how much we made per contract. You can scale up as much as you want.

But, like any investment, selling options is not risk-free…

I think StreetAuthority subscriber David W. said it best…

Hi Bob,

For those not aware of the options world, there is good information here. But what is missing is that the advice does not spell out the adverse case.

Writing puts is like selling insurance — if disaster strikes, you can lose big.

We all love a bargain. But what if the cheaper price occurs down the line because it is discovered that accounting games and fraud have turned up? Now you own a security at a cheaper price — but a price that you would NEVER buy at.

Now you could have chosen to have your decision delayed — to remain idle — and thus when the news broke about the fraud you could simply make the decision to not buy. But since you bet on the future — back when you wrote the PUT — you now have a loss, as it were.

So writing puts depends on forecasting (much like simply buying stock itself). What is needed to be successful — is not the vehicle (options, stocks, etc.) — but knowledge, so that one’s forecasting has a better success ratio.

The discussion should be about the risk management of your chip stack in the process of placing more well-judged (prudent to the chip stack) bets at the table.

-David W.

The scenario that David outlines in his note is every investor’s nightmare, and you don’t have to be an options trader to suffer the effects.

Just ask stockholders in Linn Energy LLC (NASDAQ:LINE), whose shares took a sudden 15% dive July 2 on news that federal regulators began an inquiry into accounting procedures involving a planned buyout.

David is correct in underscoring the risks in such situations for options traders. Writers of certain put options in Linn Energy LLC (NASDAQ:LINE), for instance, could have found themselves looking at double-digit percentage losses literally minutes after their options’ buy-price was triggered.

David is also on the mark when he mentions the importance of knowledge and risk management in any investment strategy. No reputable investment opportunity comes with any guarantees of success — and that includes the use of options.

But to take David’s chip-stack analogy one step further, it’s possible to increase the odds of success if you have sound strategies working for you.

And that’s where Amber Hestla comes into play. Here is an excerpt from a recent interview I conducted with Amber:

Bob: Amber, what is your response to David’s comments?

Amber: David is correct — risks are present no matter which trading vehicle you use, and there is an element of forecasting involved in any investment decision. We can’t eliminate risks, so my goal is to minimize them.

Selling puts on stocks I want to own helps me do just that.

I thoroughly research every stock I recommend selling options on. Research helps me avoid investment disasters. Cash flow is one of the most important fundamental metrics in my research. Earnings can be faked, as the former Enron demonstrated years ago, and sales can be “boosted” with various questionable techniques. But cash is real, and ensuring that cash flow is strong reduces the chance of buying into a fraud. Enron was cash-flow negative for several years before it imploded.

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