By Josip Causic, Online Trading Academy Options Instructor
In my previous newsletters I have singled out an option strategy in order to illustrate how that specific strategy works. With the exception of the last two articles on Condors, I did not emphasize
the point that any of the option strategies could be combined.
Let us look at the trade that I made last December on Apple. The AAPL on 12-04-2008 did not look to me as an Iron Condor directionless trade. While doing my technical analysis, I felt a somewhat bullish directional bias on AAPL for December yet for January my directional bias was different – bearish. On the chart below, I have marked the support at 85 with four blue ovals to indicate the strength of the support.
Figure 1
At the time of my technical analysis, I felt that in the month of December AAPL would close above 85, thus I decided to sell December 85 put. Figure 2 shows the transaction of obtaining a Bull Put.
Figure 2
The easier explanation of the transaction of Bull Put is following: I have bought to open
BTO + 1 Dec 2008 80p @ - 1.64 and sold to open STO – 1 Dec 2008 85p @ + 2.81
Max P (profit) = the difference 1.17
Max L (loss) = 3.83
ROI (return on investment) = 1.17/3.83 = 30%
In other words, I had invested $383 to make $117 under the condition that AAPL stays above 85. Figure 3 shows that at the December expiry the price was above 85 and I was able to keep the maximum profit. By the way, notice how the next trading session after the expiry the price has gone down and retested the 85 area but was not able to break it.
Figure 3
On the very same day I had entered a Bull Put spread, I also placed a Bear Call. This might sound almost as a contradiction entering a bullish trade and bearish trade at the very same time. The rule is to buy or go long at the support, which is what I did with my Bull Put.
The 85 level was the support. However, I entered at the same place and at the same time into a bearish trade.
I observed that the area around 95 was acting as a possible resistance so I sold 95 call for January. The reason for selling January and not the December 95 call, which was still trading at the time of my entry, was due to my directional bias toward the bear side after the New Year. Figure 4 shows both my entry and exit so I will first separate the two in order to provide the more accurate view of what could have been, had I held it to expiry.
Figure 4
Bear Call Entry on 12-04-2008 at 8:55 PST
BTO + 1 Jan 2009 100c @ - 6.65
STO – 1 Jan 2009 95c @ + 8.85
Max P = the difference + 2.20
Max L = 2.80
ROI = Reward/Risk or 2.20/2.80 = 79%
Self-evidently, from Figure 4, I did not hold a Bear Call until January expiry. If you would glance back on the chart above (Figure 3) you would notice that three trading sessions after my entry, AAPL was trading above 95. I sold 95 call which means that the trade has gone completely against me. The only protection that I had on my side was my conservative selection of the month of expiry. I sold January 95 call; therefore, when AAPL dropped below my sold 95 call I exited the trade by buying back my sold Bear Call. By closing it I have eliminated my exposure to risk. Moreover, I still ended up in the green although the trade had gone against me for those few trading sessions. Had I sold December 95 call, things could have been much different.
Next, I am going to separately explain the closing of each leg of my Bear Call. First let us look at the 100 call. I bought that call as a protection or insurance.
BTO + 1 Jan 2009 100c @ - 6.65 then I sold to close
STC – 1 Jan 2009 100c @ + 0.72 on 12-29-2008 at 12:59 PST
I bought 100 call for $665 and sold for $72 losing $593.
Secondly, the 95 call which I sold to open
STO – 1 Jan 2009 95c @ + 8.85 was purchased back or bought to close
BTC + 1 Jan 2009 95c @ - 1.55 on 12-29-2008 at 12:59 PST
Mathematically, the sold 95 call gave me a credit of $885 and then bought it back for $155 making $730. Out of that $730 profit the loss of $593 (from 100 call) gives $137 of profit.
In short the maximum possible reward on this AAPL Bear Call could have been $220 but because I did not hold it until the expiry, I have received only $137. Now that amount needs to be divided by the amount that was at risk (2.80) in order to get an accurate (ROI) return on investment number. Therefore, 1.37/2.80 = 49% which would mean that in 25 days (December 29th the exit minus December the 4th entry) the invested amount of $280 has earned $137. There is no bank out there that would pay us 49% in interest for 25 days. None.
In conclusion, in this newsletter I gave an example of placing both a bullish and a bearish credit spread trade on the same underlying at the same time but on the different expiry months. In the next newsletter, I will give a different example of placing two different types of bearish strategies at two different expiration months on the same underlying. In either case I am advocating for being a Net Premium Seller.
- Josip Causic
jcausic@tradingacademy.com |
