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New Trade – fixing Demand Media (DMD) – put selling

My covered call trade against Demand Media DMD turned to be a stinky trade. It turned against me when the stock dropped significantly leaving me with a large loss. Is there a way to repair it? I believe so.

What is Demand Media and why it sucks?

I must admit that when I was opening this trade I didn’t do my homework diligently. I failed to understand what Demand Media was and what was their business model. Now, with the hint-side it is clear, back then when I was opening this trade, it wasn’t that obvious.

So what is DMD? It is an internet company which relied on ranking in Google‘s search positions. This type of business is called a content farm. The company was producing a huge amount of content and relied on high-ranking which allowed them selling advertisement from great traffic.

The company also owns several other well known websites in their portfolio such as eHow, Stronger, Creativebug, and eNom domain names registrar. However their business model was based on junk content pushed forward ahead of any other content. Demand was hiring cheap freelancers to provide with junk content, videos and photographs.

When everything was OK, Demand media was generating 73 millions unique visitors monthly.

But then Google stroke them down. Google changed the ranking algorithm recently and the main outcome was to punish junk content. That had a great impact on Demand media. Soon after the monthly visitors dropped to 53 millions. The revenue followed soon after.

The stock lost almost 50% soon after.

How to fix this trade?

At this point my goal will be to close this trade at least break even. The company isn’t finished and based on the news it seems the management has learned their lesson. They will by progressing towards creating more loyal audience returning to their site and recover their ranking. As the now former CEO Rosenblatt said in his statement: “We’re not betting the farm on the old model.”

This may stabilise the company and its stock price.

I am betting on this and believe the stock reached its bottom. I only have two possible options what to do with this trade:

  1. Close the trade, take the loss and move on.
  2. Continue selling covered calls and puts against the stock to lower the cost basis and then liquidate the trade.

I decided to go for the second option. Here is my reasoning.

I already sold several covered calls against this stock lowering my cost basis and I am almost break even, see the following trades:

+ $9.50 initial purchase of 100 shares
– $0.60 sold covered call
+ $0.05 bought back covered call
– $0.45 sold covered call
– $1.20 sold covered call
– $0.50 sold naked put
= $6.80 new cost basis
= $5.20 current stock price

As you can see, my cost basis is close to the current stock price and in my opinion it makes sense to continue selling options against this stock to further lower the cost basis although I am taking more risk, mainly with puts.

On Friday I sold put against this stock to further lower the cost basis:

10/18/2013 12:09:09 Sold 1 DMD Feb 22 2014 5.0 Put @ 0.5

In November my covered call against this stock expires and I will continue selling calls as long as I get assigned.

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