5 Reasons Why I Never Sell Options On Single Stocks And Neither Should You

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Yesterday Netflix (NLFX) reported earnings and in after-hours trading the stock was down more than 25%. Yes in a matter of minutes, 25% of the market value of this poor company was gone! Today the stock closed down by nearly 35%. So what’s the point of all this Kirk? Well, I wanted to use NFLX as my "lab rat" and once again show you why I never sell options on individual companies.

I have always preferred to stick with the indexes when option selling for years now. And today really drives home the point I try to make to coaching students and readers all the time. Selling options on individual companies is bad news – and you will eventually get killed.

Here are the top 5 reasons why I don’t sell options on individual companies and stocks:

1) Earnings Gaps

Case in point today with NFLX and thousands of other instances I can point to where the stock makes a huge gap after earnings. GOOG and AAPL are also great examples of this and are highly trades yet gap all the time around earnings. All I can say is that you had better be on the right side of the gap.

2) Bankruptcy

Companies can declare or fall into bankruptcy in a matter of days. Do we even need to mention Lehman Brothers and possibly Bank of America these days? Indexes cannot declare bankruptcy nor can they ever go to zero – ever! Sure there are risks but nothing like selling options on individual companies.

3) Product/Market Shift

In our technology driven market, products and markets can virtually disappear for a company overnight. Take the iPhone for instance. When it was introduced it immediately shifted the way the landscape of the mobile and cell phone market. Cloud computing is another example that is currently stealing markets from companies and service providers. NFLX may also actually be caught up in a market where too many competitors are coming in and replicating their strategy.

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4) Merger/Acquisitions

As a former analyst for Deutsche Bank I know firsthand that companies are always looking for ways to buy market share, and at high premiums. These deals are kept secret and can sometimes send the stock gapping higher by 20-40% instantly. Likewise, the acquiring company can see their stock gap lower (people don’t often think of this scenario).

5) Rumors

Social media can spread rumors about a company or stock in seconds – seconds! Good, bad or indifferent, a stock can become the focus of the entire market before you have time to react. Buyout rumors, contract orders, drug approval rumors, etc all can cause extreme volatility.

I Forgot To Mention Liquidity!

Lack of liquidity is one last reason why I stay away from single stock options. Unless it’s a big company name like GOOG, AAPL, MSFT, etc they tend to have very low levels of option volume. Moreover, what small option volume there is cause the spreads between the bid/ask to be so wide it’s not even worth attempting an order.

Stick to the indexes for their liquidity and overall safety when selling options. They are not perfect – no market is. But they offer much better probabilities of making money and won’t give you big overnight surprises like NFLX investors saw today.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he’s a Full-time Options Trader and Real Estate Investor.

He’s been interviewed on dozens of investing websites/podcasts and he’s been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.

  • guy whitney

    Agreed.. you simply may not be able to react and sell fast enough to get out of these trades with your exit strategy intact..

  • Baxter

    I am relatively new to options trading but this is a strategy I recently discovered on my own. A stock can cut in half in less than a day, terrifying. Could the Dow 30 cut in half in a day? If they did there would be larger issues at hand!!! I am a recent subscriber and would love to know more about the indexes you play and how you play them. I have been buying calls and puts on the $DIA, $SPY, $QQQ, $NDAQ are there others? I would love to know about them.

    thanks for all your great work!

  • James

    While this may be something that one should definitely consider when trading options, I don’t think it’s needs to be a hard set rule. How about all those traders holding options in ’08 and early ’09? How many of them had the capital to stay afloat? Dividend paying, blue chip companies are a decent safe bet as well. JNJ, XOM, KO, MSFT, etc.

  • bachir

    Let me first thank you for the great wealth of information you provide us. We are greatful to you. I am a sparky by trade. I built the ultimate and latest state of the art trading computer system. If you know anyone interested in building their own trading computer, please let them know that I can share with them for free all the information about my system. Pay it forward!

    You said you “Never SELL options”. Do you BUY individual companies options?

    • Kirk

      Not typically unless they are a big name company like Apple or Google.

  • Bill Place

    Have done quite well buying calls on PG, WMT, wag, Gis, jnj, MCD, Mo. I buy these calls out like 3-6 months. Buy and sell these over and over on pullbacks until the stock itself hits about 3 percent gain, wait for pullback and do it again. Like to hear feedback on this. To me much safer then spreads. Thoughts please

  • Hey Terry! Your right, when markets move up (forgetting earnings for a bit), the move is less volatile compared to when they move down. My concern on single stocks is that the big down moves would be more dramatic. Hope this helps and great question!