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When My Trade Goes Against Me, Can I Still Be Profitable?

josipcausic
Josip Causic
Instructor

“When my trade goes against me, can I still be profitable?” a student asked me once. My answer was given in the manner of an attorney – “It depends.”

Later on, I looked through my numerous index cards where I record my option trades in order to locate one that somewhat matches the answer to this question. I was able to find one from May of 2006 with three contracts. It is important to emphasize the size, three contracts, because this article will show that I partially scaled out of my initial position leaving the last part on. Hence, to answer the original question: (Could a spread trade go against me and yet still turn out to be profitable?) possibly yes, assuming that the trade had more than just a single contract. Having more contracts gives additional choices for this situation.

Let me go over the specifics of my spread trade: The S&P 100 cash settled index was trading at 577 on the day I sold three Bear Call spreads.

$OEX Bear Call Spread Intrinsic Dollar Value
$577 BTO +3 June Wk A 585c @ 3.10 None 930
$577 STO -3 June Wk A 580c @ 4.90 None 1,470
5/30/06 Max L = (585c-580c) – 1.8 = 3.2 Max P 540

Figure 1: OEX @ 577 (Day 1)

According to my bias based on the Bearish Divergence of a certain technical indicator, I was willing to take a calculated risk with this extremely aggressive trade, which was opened on the weeklies. By the close of the very next day, it was proven to me beyond a reasonable doubt that I was on the wrong side of the order flow, so I chose to bail out by completely closing my obligation.

$OEX Short (580 call) Leg = Obligation Intrinsic Dollar Value
$577 STO -3 June Wk A 580c @ 4.90 None 1,470
$581 BTC +3 June Wk A 580c @ 6.90 One point 2,070
Loss $600

Figure 2: OEX @ 581 (Day 2)

Reading the above table line by line, we have the line of my entry 580 call (with no intrinsic value) when the OEX was trading at 577, followed by the line below with my exit (of the 580 call with one dollar of intrinsic value) when the OEX was at 581. The last line shows a loss of $600. Exiting my sold legs and leaving all three of the long legs open, I was exposed to the possibility of a market reversal back in the previous direction. However, that was the chance I was willing to take at the time; fortunately, my choice turned out to be the correct one.

$OEX Long (585 call) Leg Intrinsic Dollar Value
$577 BTO +2 June Wk A 585c @3.10 None 610
$587.25 STC +2 June Wk A 585c @5.60 2.25 1,120
Notice one 585c is still left open Profit $510

Figure 3: OEX @ 587.25 (Day 3)

On the third day of being in the trade, the OEX traded up and closed at 587.25 and I was glad to see that I was profitable on three of my long calls that I left open. Although the table above (Figure 3) shows a profit of 510 dollars, we must subtract the 600 loss from the short calls (see from Figure 2). In addition, observe that I exited only 2/3 of my long 585 call leaving a single call still open. On Friday of expiry, the situation was the following.

$OEX Long (585 call) Leg Intrinsic Dollar Value
$577 BTO +1 June Wk A 585c @ 3.10 None 310
$589.40 STC +1 June Wk A 585c @ 5.90 4.40 590
Profit $280

Figure 4: OEX @ 589.40 (Day 4)

My last contract of the 585 call was not as profitable at expiry as it would have been had I exited the day before when the premium was composed of both the extrinsic and intrinsic value. Observe on Figure 3 that when I closed the 585 call (OEX at 587.25), the intrinsic value was 2.25 and I was able to sell it for 5.60. The next day, the OEX went two points up (to 589.40), and my closing premium was only 30 cents higher. Think about it, the OEX was up 2.00 and my premium increased only 30 cents. Was I wrong leaving the single 585 call on? Undoubtedly! I managed to make an error in judgment at the exit as well, though I was still successful.

In conclusion, this article has illustrated that occasionally, it is possible to break even or even make a small profit on a trade that goes against you. Keep in mind that after scaling out, the market can also reverse back in the original direction and in that case, regrets in the back of our mind might kick in, so expect them. Ergo, always be accountable for your trades and do not blame the market for any of your decisions at the entries or the exits. Ultimately, it is the trader’s responsibility to manage his or her position.

Josip Causic

Disclaimer
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.