Dykstra: Averaging Down Is Key

Keep additional funds available in case a pick's stock price drops and you have to average down to put yourself in a better position for a win.
Publish date:

My deep-in-the-money options trading system had a good start to the week with two wins on Monday, bringing my record to 98-1. For the picks, I do the legwork so that you don't have to. However, investing is serious business, and my system has guidelines you should follow if you want to ring the register with me.

Today, I will explain the concept of averaging down on a position and why it's crucial to my strategy.

I pick good companies whose stock prices are beaten down more than they deserve. Because these are solid companies that have fallen victim to broader market forces, they stand to recapture some ground as markets start to recover.

They don't need to come all the way back to their one-year highs for us to win. We just expect them to move up enough to give us a $1 boost to the price we paid on the option, so we can add $1,000 to my scorecard -- or $1 a share on 10 contracts of 100 shares each.

I don't advocate a long-term, buy-and-hold strategy, but I do give my picks plenty of time to meet my goal. I pick these companies because they fit my strategy and put us in position to make money when they bounce. We are waiting for them to bottom. That doesn't always happen. We can't foretell the future or anticipate unexpected bad news from a company.

Sometimes our prediction is a little off at the outset. Inevitably, some picks will fall further before coming back into their own. And when stocks fall, we turn that to our advantage by averaging down. When the price of a stock goes down, a DITM-option price drops as well. That's our opportunity to buy more contracts at lower prices. I do this in order to lower my average entry price.

Here's an example. We got the call options in my pick


(CSCO) - Get Report

at an average price of $8.10 a share on Dec. 12, when the stock closed at $16.99. I recommended placing a good-till-canceled sell order $1 above our entry price -- in this case at $9.10.

In mid-January, the stock began to drop. When that happens, my system calls for subscribers to place re-buy orders at specified price levels. When shares of Cisco fell to $15, we bought 10 more call contracts at a lower price. This lowers the average cost of each contract and each GTC order. Because options trade in 10-cent increments, some rounding may be necessary as the price of GTC orders drops.

By the time Cisco's share price rebounded to $17.00 on Monday -- enabling us to sell our positions -- we had 40 contracts at an average cost of $6.40 a share and an average GTC order of $7.40. Gradually over the course of 103 days, we had committed approximately $25,600 to the position. When we took our win, our net profit on the investment was $3,900.

I've recorded similar multi-buy wins, such as $5,800 on


(GLW) - Get Report

Jan. 6; $5,200 on


(NOK) - Get Report

on Dec. 17; $7,100 on


(HAL) - Get Report

Dec. 11; and $7,650 on


(ADM) - Get Report

Nov. 4.

Of course, I also get quick wins of $1,000 on the original 10 contracts, sometimes within a day of buying the positions. On Monday,


(HPQ) - Get Report

paid off after just seven days in play. And on March 10,

Cameron International


rang the bell after eight days.

With my system, it's important to keep additional funds available in case a pick's stock price drops and you have to average down to put yourself in a better position for a win. It's a significant part of my strategy for successful options trading.

At the time of publication, Dykstra had no positions in stocks mentioned.

Nicknamed 'Nails' for his tough style of play, Lenny is a former Major League Baseball player for the 1986 World Champions, New York Mets and the 1993 National League Champions, Philadelphia Phillies. A three time All-Star as a ballplayer, Lenny now serves as president for several privately held businesses in Southern California. He is the founder of The Players Club; it has been his desire to give back to the sport that gave him early successes in life by teaching athletes how to invest and protect their incomes. He currently manages his own portfolio and writes an investment strategy column for TheStreet.com, and is featured regularly on CNBC and other cable news shows. Lenny was selected as OverTime Magazine's 2006-2007 "Entrepreneur of the Year."