Lessons Learned – Lumber Liquidators Pummels Investors – Investor Questions

I received a lot of emails over the past couple of days from investors who thought they had Lumber Liquidators stock figured out. All but one investor who have written are holding losses and most keep pointing out that Delta was negative 13 on the trade. One investor wrote “Delta is always right isn’t it?” Another investor wrote “I got killed last year in this stupid stock. I did the exact same thing, sold puts. Am I an idiot? ” Another one said “I made $1.75 on the put but now it is over $8.00 to buy back. My loss is wiping out months of work Teddi”. Still another investor “I can’t sleep. I feel sick. What a stupid think for me to do.” Finally another investor emailed “I don’t have enough capital to cover all the naked puts I wrote. I got called on it and have losses of $15,000.”

Forget The Greeks

I cannot stress enough how important it is to not believe the Greeks and what you think they are telling you. Remember speculative stocks are just that, speculative.

High Option Premiums = High Risk

Option premiums are priced according to risk. Speculative stocks often have higher premiums because they are more risky.

Using The Right Strategy Can Pay Off

In amongst all the emails was this one which I received was from an investor who had written me in advance of placing a trade. He wrote, “Thanks Teddi for your advice. I did the credit put spread and while I lost big on the spread, I made a lot more on the long put”. Using the proper strategy is absolutely essential on speculative stocks and for many investors, on any stock. I had explained to this investor that the credit put spread while it did not initially make as much as the naked put did, would provide some protection in the event that rumors proved to be true and the stock plunged further. While the spread was $5.00, the plunge of the stock was enough to cover the loss and make some profit from the long puts.

Selling Puts On The Initial Drop

The initial drop of the stock on Feb 25 saw a lot of investors selling puts at the $50 to $45.00 put strikes with some going to April 17 expiry and others choosing March 20 expiry. The stock then plunged further on March 2 to $38.19 before closing at $38.83. This marked a decline of about $30.48 in just 4 days, a loss of 44%. Investors holdings these naked puts are looking at steep losses to buy back their puts and this morning I received a few more emails from investors who have had shares assigned early.

Most are seeking some advice on what they could do to recover their losses or get out with minor losses or even a break-even. Perhaps the biggest help may come from promoters. The news of a buy call by a couple of analysts including one this morning on CNBC has jumped the stock to $43.07 so for those who sold the $45 or lower naked puts, this may provide a chance to get out with only small losses.

Lumber Liquidators Chart

The carnage in the stock can be seen below. This is the lowest level for the stock since 2012. The first thing to mention is that this is a highly speculative stock. The past few days have seen the biggest volumes in the stock’s history. However the outflow of capital was actually stronger back in mid-January. That does not mean more shares left the company. It means that the strength selling pressure was worst. That means that sellers dumping shares over the past several days may not be aware that someone is busy buying those shares. While money flow shows the strength of selling is close to the pressure seen in mid-January, it is telling that with the volume being the biggest in the stock’s history, it was contained. In other words, investors selling, were finding ready buyers.

lumber Liquidators Stock (LL) chart

Lumber Liquidators Stock

These types of stocks can destroy an investor’s portfolio. They are highly speculative and absolutely among the worst stocks for the average investor to be considering. The chart pattern below of Lumber Liquidators shows just how many investors have lost money in this stock. In the fall of 2013 the stock was trading around $119.00. By Feb 2014 it was at $105 and by July 2014 it was at $75 before plunging to $54.00. These are not the kinds of stocks to invest in, in my opinion. Selling put options can result in disaster. Earning even $1.50 on selling a put and then ending up closing the trade for $5.00 or $6.00 is a shocking loss.

Lumber Liquidators Stock 3 year chart

Saving Capital

Short sellers are holding a lot of stock which could be a good thing. If promoting the stock works, some short-sellers could be spooked and cover their short shares. This will assist in pushing the stock higher. There is a good chance the stock might recover to $50.00 in a short period of time. For most who have written me, this will allow them to exit their trades with none or just small losses.

On any rise in the stock, investors could consider slowly reducing the number of naked put contracts sold. This would allow them to save some of their capital and should the stock move higher, they will still be able to close other positions for less cost if the stock rises. If instead the stock falls further, at least some of the losses will be minimized.

Lumber Liquidators Stock to Mar 3 2015

Problems and Repairs

The problem with these speculative trades is that placing more capital in the trade to try to rescue the trade often ends with even larger losses. If the rumors on their products turn out to be correct, the stock will definitely fall further. Short sellers are obviously holding on with the belief that the rumors will turn out to be fact.

Since I see no way to add more capital to these trades without increasing the risk of losing more capital the better and easiest choice is to try to reduce losses by closing naked puts if the stock continues to rise. Rolling down always makes sense on big cap names that I trade but with speculative stocks it comes down to whether you can comfortably move lower without adding in more capital and without taking any losses. You must also be fully aware that should the rumors of the company turn out to be factual, then rolling down will probably not save positions.

Investors could consider buying puts once the rally in the stock begins to end. Buying 3 month out puts that are out of the money may prove the best way to regain lost income if the rumors are true since the stock will plunge. However waiting for the stock to rally back and then stall and finally start to turn lower would be the best time to be considering buying put options to protect any remaining naked puts.

Stay Far Away

With so many large cap, dividend paying company to choose from, why trade in speculative stocks? While premiums may seem above average, it is because there is more risk to the trade. Higher option premiums always equate to higher risk of capital loss. Stocks are inherently incredibly risky assets. Why add to that risk by trading in speculative stocks. Instead for almost every speculative stock there are quality large cap stocks that if they declined in value, you would want to be place more capital at risk. Imagine a Johnson and Johnson stock losing 44%. Thwt would move the stock from $102.16 to $57.11. At that price I would be selling in the money naked puts and loading up.

It would be nice to be able to do the same with a company like Lumber Liquidators but for most investors, it is foolish to risk more capital in this trade. Instead staying with large cap dividend paying companies provides a level of protection companies like Lumber Liquidators cannot.