Bad News for Toyota (TM): Is it Time to Rethink Your Investment Positions?

2010 is shaping up to be a rough year for TM (Toyota Motor Co), first problems with the Prius and several other models with reported ‘sticky’ accelerator issues and now the dangers affecting an SUV in the premium Lexus Line. A fresh review of the 2010 Lexus GX 460 by Consumer Reports magazine revealed serious concerns with the vehicle. The publication issued a rare “don’t buy” recommendation for the 2010 Lexus GX 460 sport-utility relating to roll over risk.

Consumer Reports already suspended its recommendations for eight other Toyota models earlier this year.

In the first three months of 2010, Toyota sold about 4,800 of the GX 460, with sticker prices starting at about $52,000.

I bring this up, not to slant Toyota in any way, but to make you aware of the unexpected things that can often occur with a publicly traded company.

Planning Ahead

When you are selecting a company to invest in, you should be obviously do your homework and learn about the company itself, but there are several other matters to consider, including:

• The business of the company
• Overall macro climate of the industry sector
• Earnings history
• Prospect of future earnings

Earnings and prospect of future earnings are especially important to consider since they are typically a large determining value in stock price. However, even with all the research in the world, surprises can occur. This brings to light the importance of having a contingency plan or exit strategy if something fundamentally changes with the company.

When Should You Exit?

A good contingency plan will depend on the amount of time you anticipate being in the trade.

This pullback in Toyota stock may present a buying opportunity for some because of the company’s long-term time horizon. Others with short-term positions may choose to exit the trade.

For options traders, we can, through the use of certain strategies, limit our total risk in a particular trade. For example, at the end of last year, TM stock was trading near $85.00 per share. Some bullish options traders may have chosen to sell a March 86/80 put spread for a credit of $2.00 (estimate). This particular trade would have potentially limited your risk to $3.00, which is the width of the spread minus the credit.

When stock dropped from its high of $91.50, down to $71.00, a stock trader who was long at $85.00, would have an unrealized loss of $14.00, while the options trader may have realized his maximum loss potential of $3.00, no matter how far the stock dropped. Granted, the bull put spread is also limited in reward, with the credit received being the most the trader could make. But with the risk reduction, the return on risk in the put spread is actually 67%. A stock investor would only realize this same rate of return on risk assumed if the stock went up almost $57.00.

There are risks and rewards to stock and option investments, but both should be considered when evaluating a company for potential investment since you never know what news could be lurking around the corner. Remember positive news can affect a stock’s value as well!

Do You Sense an Opportunity or a Bad Omen?

Does this bad news for Toyota have you selling off positions or does the recent drop signal a time to rethink your current positions? Please share your thoughts in the comments.

Investors: OptionsHouse has some of the most competitive rates for stock trades as well as options. You can also take our platform for a spin in a virtual trading account.

Photo Credit: kenjonbro

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