I’M USUALLY BORING when it comes to investing. My portfolio is mostly comprised of stock and bond index funds. I dabble in individual stocks when I come across something I see as interesting, but individual stocks have never made up more than 5% of my portfolio. I currently hold just three individual stocks amounting to less than 2% of my investment holdings.
While my interest is occasionally piqued by stocks with upside potential, I’m more often drawn to companies I see as having significant downside. This glass-half-empty orientation likely reflects the professional skepticism that comes with being a CPA. I’ve never acted on my bearish instincts—until now. Recent developments at Peloton Interactive (symbol: PTON) have led me to wager that the stock will continue declining.
I’ve followed Peloton closely for years. I love its product. But a series of management missteps have caused me—and many others—to become bearish on the stock. The company’s troubles have included bungling a product recall and unexpectedly bad financial performance. The last straw for me: Peloton recently raised $1 billion through a stock sale—just two weeks after the company’s chief financial officer indicated such an infusion of capital was unnecessary.
To act on my bearishness, I decided that buying a put option was the most prudent approach. Unlike shorting a stock—which has an unlimited downside if shares rise—a put option limits my possible loss to the premium I pay for the put. After considering the array of options available, I paid $200 for a put that gives me the right to sell 100 shares of Peloton at a “strike price” of $35 a share in April 2022.
There’s a wide range of possible outcomes for this option position, but I’ll give two possibilities. If the stock trades above $35 in April 2022—which is likely, given that the shares have lately been trading in the low-to-mid $40s—my loss will be the amount of the premium. If the stock trades below $33, however, I stand to make a profit.
For instance, if the shares trade at $30 in April 2022, I’ll earn a $300 profit. How so? I’d make $500 by exercising the put and selling 100 shares at the $35 strike price, equal to $3,500—shares for which I’d only need to pay $30 each, or $3,000 total. That $500 gain would be partly offset by the $200 premium I paid for the put.
If I don’t like holding this option over the next few months, I can sell it at the market price, just as I could any stock holding. Yes, this is a small investment. But I’m a person who learns by doing. The worst that can happen: I’ll have paid $200 to get an education in options trading.
