4 Steps to a Successful Option Trade

02/12/2014 8:00 am EST

Focus: OPTIONS

Part of our covered call writing education involves looking back on both successful and unsuccessful trades and learning from them, says options expert Alan Ellman of TheBlueCollarInvestor.com, and here, he reviews a previous trade.

A few months ago I shared with a premium member a trade I had executed the previous month and saved it. Today's article will highlight a trade I made last September and October with a happy ending.

Proto Labs Inc. (PRLB) was a stock on our Premium Watch List with outstanding fundamentals and technicals. I sold multiple contracts on this security but will use 100 shares and one contract to simplify the math. Here's the overall trade:

  • 9/23/13: Buy 100 x PRLB @ $78.10
  • 9/23/13: Sold 1 x October $80 call @ $3.30 for an initial one-month return of 4.2%
  • 10/8/13: Buy-to-close the $80 call @ $0.45 (slightly higher than our 10% guideline.that's why I call it a guideline!)
  • 10/14/13: Sell-to-open the $80 call @ $1.40 for an additional $95 credit/contract ($140 - $45)
  • 10/18/13: Allow assignment as stock is trading > $80 and there was an upcoming earnings report on 10/31/13
  • 10/19/13: Shares are sold for $80 for an additional $190 per contract (purchased @ $78.10)
  • Total profit = $330 + $95 + $190 = $615/contract = 7.9%, 1-month return

Let's take a look at a one-year chart, which included this trade:

chart
Click to Enlarge

Please note:

  1. Entered trade
  2. Hit a double as share price declined and then recovered
  3. Allowed assignment as share price was in-the-money at expiration

Let's now take a closer look at the one-month chart:

chart
Click to Enlarge

Summary:
Here is a summary of the BCI principles, rules and guidelines used in this successful trade:

  • Stock selection using fundamental and technical analysis, as well as common sense principles
  • Option selection based on market assessment, chart technicals, and risk tolerance
  • Exit strategy execution using the 20/10% guidelines
  • Expiration Friday decision based on earnings report rule

By Alan Ellman of TheBlueCollarInvestor.com

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