What I Learned from a Recent Option Trade

10/19/2009 11:15 am EST

Focus: OPTIONS

In my last article, I explained the reasons for entering into a bearish trade. I also provided a possible repair for a vertical spread by turning it from a bearish trade into a bullish one. However, here in this article, I will expand on what really happened to that particular vertical trade described in the previous article. I will present the scenario in greater detail which involved exiting for a profit after being in the trade for only a few days.

Once again, the specifics of these trades can be found by clicking on this link. For those who just care about the bottom line, the facts follow. The Bear Put (bought vertical put spread) was opened on Tuesday 09-29-2009, while the underlying was sitting at 30.36 and it involved these two October contracts: Long (ATM) 31 put bought for 1.41 as well as short (OTM) 30 put sold for 0.90; together, they have produced a debit of 0.51 cents. The width of the spread (31 put minus 30 put) was a dollar and when the maximum loss of 0.51 cents is subtracted, then the maximum profit becomes 0.49 cents.

Making the Bear Put Profitable

In other words, for this Bear Put trade to be profitable, the price needs to be below the sold October 30 strike price. When the position was initiated, the underlying was trading above 30, which is one of the reasons why the premiums were at the levels that they were.

Figure 1 below shows the same daily chart as what was in the previous newsletter on which the existence of a Shooting Star was emphasized. Observe that a pink horizontal line was used to mark the zone of 30 which acts as a significant support/resistance area.


Click to Enlarge

On Figure 2, the timeframe is changed from daily to a 15-minute chart. There are two markings on the chart that need to be explained: The yellow oval with the red arrow points to the entry into the Bear Put. The green rectangle with the blue arrow marks the trade exit while the product was trading at $29.14.


Click to Enlarge

The figure above illustrates the point that the long leg produced a profit of 0.70 cents; whereas the short put produced a loss of 0.40; therefore, the difference of the two is 0.30 which at first might not appear as much. The initial calculation of the Bear Put was that the maximum profit could amount to 0.49 at expiry. In this case, the profit was only 0.30 cents which is more than half of the maximum profit in less than five trading sessions.

The next figure shows the prices of the individual option strikes. The text on the chart explains the specifics of each contract. The ovals and rectangles have the same meaning as on the actual underlying which is explained in Figure 2.


Click to Enlarge

In conclusion, I have presented the closing of a vertical spread trade in great detail. Although the maximum profit was not achieved, the majority of the maximum profit was scooped up after being in the trade for only a few short days. As the chart shows, had there been any hesitation and the profit not taken, then the profit would have been given back, because the price has since gone above 30 again. Have green trading and do not be greedy.

By Josip Causic of OnlineTradingAcademy.com

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