There’s No Magic Cure for IBM Stock’s Brutal Selloff, But This 1 Options Trade Comes Pretty Close

You know what happened by now. International Business Machines (IBM) proved on Tuesday that a gruesome, single-day plunge can hit anyone, at any time. IBM’s sudden jackknife of a stock move feels akin to getting hit by a truck. And while the initial panic has faded, the wreckage remains. 

IBM’s 25% dive was its worst one-day drop since 1968. The stock erased $65 billion in market value in a single session. The failure did not stem from a broad economic slowdown, but from a dramatic, overnight shift in how big businesses are spending their cash.

But I’m not here to talk about the past. 

Let’s look ahead, and return to the concept I refer to as a “dog collar.” The basic elements are in place:

• Prominent stock shot down, creating a “fallen angel” situation.
• Solid option liquidity.
• Decent option pricing. 

How to Find a Dog Collar Trade on IBM Stock 

When an asset gaps down overnight, there is no “magic eraser” to undo the damage. The loss is locked in. If you want legit, ironclad insulation against sudden single-stock air pockets without liquidating your core positions, I have always looked past stop-loss orders, and instead considered an options collar. 

A collar is a proactive risk-management strategy that builds a contractually guaranteed floor under your shares, funded in part or whole by the market itself. 

To build one, you execute two simple steps on a stock you already own:

• Buy a Protective Put: You purchase a put option at a strike price slightly below the current market value. This functions as a bulletproof insurance policy. No matter how bad a surprise earnings warning is, and no matter how far a tech general gaps down overnight, you hold a legally binding contract to sell your shares at that fixed price.
• Sell a Covered Call: To avoid paying a ton out of pocket for that put insurance, you simultaneously sell a call option at a strike price above the current market value. The premium cash you collect from the call buyer offsets some or all of the cost of the protective put.

The tradeoff is clean and transparent. You give up your upside potential past the call strike if the stock continues to rip higher. In exchange, you eliminate your downside tail-risk below the put strike.

In the case of my dog collar strategy, the net cost of the collar, if any, is often the only cost because I strike the collar close to the current stock price. Let’s see if IBM offers such an opportunity.

There are so many combinations in situations like this, it is very much “dealer’s choice.” But to help you along, here’s a sample of one collar combination I like. 

What prices make sense to me? For starters, while I’d hope to get the stock all the way back to its high water mark of $332, I’m not the greedy type. And I do not want to risk more than 10% in any case. If I can get away with 5% max drawdown net of the option cost, that’s my true objective. And I’ll sacrifice some upside to do it. 

Here’s what I found:

I’m going out on January 15 of next year, so just about six months. I found a $310 call strike, which is near IBM’s more recent high, just before Tuesday’s train wreck. That brings in around $7 a share in option premium. 

The put side is struck at $225, which is actually 4% above Tuesday’s close. But I like it because it sets my worst-case scenario at a 9% loss. That, versus a 30% upside cap is a 3.3:1 up/down ratio. Very nice. 

This is why I love the dog collar concept. When a stock like this falls, it is at least a coin flip chance the market will forget about it in a few months. I’m giving myself six months. And with IBM’s Implied Volatility having spiked to 50%, and IV Rank of 88% (close to its highest over the past 12 months), there’s a lot to like here. 

In a late-cycle tech market where corporate spending shifts can wipe out a quarter of a giant’s valuation in a single morning, I think it makes a lot of sense to consider a collar. So you won’t feel like a prisoner to the stock market’s whims. 

Rob Isbitts is a semi-retired CIO, former fiduciary investment advisor, and Barchart columnist. Check out his other work at ETFYourself.com (featuring the Fresh Charts weekly trading post), and ROAR.PiTrade.com, helping investors to better-manage their own portfolios.