Pfizer Inc. (PFE) dropped a bit after lowering its 2015 guidance as part of its latest earnings release on April 28, but it looks like investors are starting to move back into the stock as it bounces up off of the up-trending support level that was originally established between November 2014 and January 2015. We expect the stock to move back up toward its recent highs near $35.50.
PFE continues to be a perennial powerhouse in the pharmaceutical industry and, with health care spending being the one sector of the U.S. economy that is continuing to see growth, we anticipate Pfizer will continue to grow as well. The company has a variety of drugs that are making their way through the approval process, and the company continues to invest in and acquire other smaller firms with promising drug pipelines.
PFE is also a strong dividend-payer, which enhances the stock’s appeal as a defensive stock.
‘Buy to open’ the PFE July 35 Calls (PFE150717C00035000) for a maximum price of $0.50.
As we continue to trade through this extended consolidation range on the S&P 500, we thought it would be helpful to share our advice on perhaps the most important tenet of successful investing: money management.
When it comes to trading options, the most important part of money management is position sizing. For instance, with our Pfizer call trade, how many option contracts should you buy? One contract, five contracts, 10 contracts?
The answer depends on how much of your portfolio you want to risk in any one trade.
Imagine you have $25,000 in your portfolio, and you decide you only want to risk 3% of that, or $750, on any one trade.
For the PFE July 35 Calls in particular, with an ask price of $0.50, the cost of buying one call would be $50 ($0.50 x 100 shares). Then, all you have to do is plug the data into this simple formula to determine how many contracts you should buy:
(Amount at risk ÷ price per contract = number of contracts)
So, if you only wanted to risk $750 in this trade and each contract cost $50, you could buy 15 contracts ($750 ÷ $50).
One of the questions we often get is “Do you use stop losses on your option trades?” Because we typically use at-the-money (ATM) or slightly out-of-the-money (OTM) strike prices, we typically don’t use stop losses. We simply rely on our position sizing to control our risk.
However, for those of you who prefer to add a stop loss, you will need to make the following change to the position-sizing formula:
((Amount at risk ÷ stop-loss percentage) ÷ price per contract = number of contracts)
Let’s say you are planning on setting a stop loss at 40% for our PFE July 35 Calls. You could now buy 37 contracts (($750 ÷ 0.40) ÷ $50 =37.5).
Now, using a stop doesn’t mean you are guaranteed to be taken out of your trade at that price. If the price drops too quickly, you could end up losing more than you had initially planned…so, keep that in mind before using a stop. Again, we prefer not to use hard stops on our trades.
As option traders, we never know what the market is going to throw at us. That is why it is crucial we maintain discipline over the areas we can control. Money management — position sizing in particular — is one of those areas. Make sure you are tailoring your risk level to meet your needs in your portfolio.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next SlingShot Trader trade and get 1 free month today by clicking here.
You can learn more about identifying price patterns – like a bearish head and shoulders top – and using them to project how far you think a stock is going to move in their Advanced Technical Analysis Program.
