Choosing the right strategy doesn’t guarantee results, as evidenced by these weekly option trades gone wrong. See additional factors that can turn the market against you and take proper precautions.
Recently, I was teaching an options class at Online Trading Academy Dubai and a trader had applied a credit spread strategy that we had just covered in the class, live in the market. Sometimes, the worst thing that can take place for a new trader is to have a string of winners. Those winners can send out the wrong message that option trading is easy, and no further education is needed.
In the case of this Dubai student, the experience was exactly the opposite. He had taken a couple of trades and they turned out to be losers. Unlike having too many winners, after having several losers, there is a tendency to question whether a strategy works at all.
After communicating with him via E-mail several times and asking him to provide me with the specifics, I was able to reconstruct a somewhat accurate picture of what had taken place. I also asked him for permission to share his trades and my insights with you, the audience.
The first trade was on Google, Inc. (GOOG), and here are the specifics of it:
GOOG was trading at $500.40 on Friday, August 19, 2011, with the immediate resistance at $525. A bear call spread was done involving the sale of the 525 calls and the purchase of the 530 calls. At the time, the implied volatility (IV) of GOOG was high. The sale of the 525 call meant that the upside protection was $24.60 (from $500.40 to $525).
The exact transaction of his trade was as follows:
Buy to Open (BTO) + 1 Aug (wk4) (6 x OTM) 530 call @ $1.15
Sell to Open (STO) – 1 Aug (wk4) (5 x OTM) 525 call @ $1.70
Max Profit: ($1.70 – $1.15) = $0.55
Max Loss: (530 call – 525 call = $5 – $0.55) = $4.45
Rate of Return (ROR) = Max P/Max L = $0.55/$4.45 = 12%
Breakeven Point (BEP) = Sold strike pl! us the c redit, or $525.55
The trade listed above is shown in the chart below, which has Bollinger bands on it. The green horizontal line was his entry price and the vertical, dotted black line was the exact date of the entry.
The trader had two exits placed on this trade, also known as order cancels order, or OCO. The first one was to buy to close the sold 525 call for a nickel with a “good ‘til cancelled” (GTC) order. The second one was a GTC conditional order stating that the whole spread should be exited at the market price if GOOG trades at or above $525.
As you can see on Figure 2 below, on Wednesday, August 24, 2011, the stock rallied above that $525 level (marked on the chart with the red horizontal line) and took him out by closing the entire spread. According to his facts, he lost $2.20 on the spread. Though he lost, I consider this a good trade because he followed his clearly-spelled-out rules for exit.
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