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How to Cover Your Assets in a Speculative Stock Position

Stocks in this article: YHOO P AAPL

That's the type of hedge I like to make on speculative plays. The premium I collect from writing the calls helps cancel out or offset downside, depending on the extent of it. And, if I get my shares called away, so be it. I will have returned 4% on the trade (buy at $15.89/sell at $16.50) in just over a week's time.

On broad market weakness or something stock-specific, I can buy more YHOO shares to add to what's left of my position, assuming the bulk of it gets called away at options expiration. For the record, I don't think it will.

Now, consider Pandora.

I accumulated shares, settling on a cost basis of $10.19.

Hindsight can have this effect, but I could kick myself for not taking at least some profits in Pandora at or around its Sept. 6 closing high of $12.57.

Thanks to rumors that Apple (AAPL) has plans to introduce a competing service, the stock sunk as low as $9.95 on Sept. 7, closing that session at $10.47. It's been a rough ride from there. Pandora has spent time under $9 per share, ending the day Monday at $9.10.

If I sell at $9.10, I record a 10.7% loss on the trade. Not awful, but considering the 20-plus percent gain I let slip away, it's a minor irritant.

Here's what actually happened. I ended up selling some, though not all, of my Pandora position at $9.00 over the weekend. That's because I got assigned on Pandora Oct. $9.00 calls I wrote against the position. I was merely continuing a strategy I have had in place for months -- writing around-the-money calls against 600 shares of Pandora.

A straight stock sale at $9.00 from a cost basis of $10.19 results in an 11.7% loss. In real dollars, that's proceeds of $5,400 from a cost basis of $6,114. Again, not very satisfying. Of course, that's not what I did because that's not how I roll.

It takes some discipline to stick to prudent rules you set for yourself, particularly when dealing with speculative plays. That's because of the huge reward you often calculate in your head on stocks with significant upside.

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