Defensive investing example

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Joe (not his real name) was bullish on Google when Google was trading at $100 per share, and he decided to buy 10 May 100 call options at $8 each ($8,000 total). The stock rose to $130 per share, and Joe was excited when his options rose to $32 ($32,000 total). But when the stock began to fall, Joe had visions of losing his entire investment in the options, so he sold when the calls fell to $7 (total $7,000).

However, Joe felt comforted by the fact that he had only lost $1 per contract ($1,000 in total). Joe was still very bullish on the stock, but he was afraid that the stock would quickly fall again and he would lose money, so he decided not to get back in and not to buy any calls.


As the weeks went by in, Google went up to $500 a share (his options would have been worth $400,000, a profit of $392,000, based on his original purchase price). Joe was devastated and went into a 12-step relaxation programme to cope with the thought that he had sacrificed so much money because he was worried about protecting a relatively small amount. The mistake he had made in the Google trade, in his opinion, was that he had not held on to his call option long enough.

Joe thought he had learned his lesson, so he decided that he would not be so quick to sell his options when the next high-flyer stock came along. Joe bought 50 calls of XYZ Corporation at $3 ($3,000 total) on 10 July when the stock was trading at $50 per share. 

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The influence of trading news

Joe watched CNBC every day and heard about XYZ's great prospects. Of course, the stock began to rise, and when it reached $60 per share, Joe decided that he should make up for his Google mistake by buying 20 more July 50 calls at $13 each ($26,000). Joe was determined to get back the money he felt the market owed him because of the Google debacle and felt comforted by the fact that the experts on CNBC were bullish on the stock.

When the stock hit $90 a share and his profits grew to over $100,000, Joe called his friends and family (and the buddies he had met in his 12-step recovery programme) to tell them how easy it was to trade the financial markets if you were talented and smart. When the stock hit $100, it started to turn and go down, but the CNBC pundits proclaimed that this was just another buying opportunity. He started listening to more pundits on TV and joined the crowd thinking that when stocks go up, it's good because people are making money, and when stocks go down, it's good because it's a buying opportunity.

What a great country. When the shares fell to $65 a share Joe thought that this could be another buying opportunity and bought more options and was even more optimistic because that because the company was due to announce its earnings the following week. Joe felt particularly optimistic because so many people were saying good things about the company's prospects. He felt that although the Google trade was devastating, but he was smarter than most people and he was confident about its investment capabilities. He was looking forward to XYZ Corporation's results and decided to hold all his options. However, when XYZ Corporation's earnings were released, the stock crashed, dropping to $30 per share, and Joe lost his entire option premium.