Thursday, May 21, 2009

Bear Call Recap

We had some nice follow thru to yesterday’s bearish reversal. One of my bearish strategies of choice is a bear call spread (i.e. selling call spreads). As the market staged an intraday reversal yesterday I entered some RUT June bear call spreads. The purpose was two-fold:

1. I’ve already got quite a few bullish trades primarily on commodities which had nice profits after Monday and Tuesday’s strong moves (AGU, USO, ANR, ICE…). Typically after the market stages a strong rally, I like selling OTM call spreads on an index such as the RUT to serve as a hedge for my existing bullish trades. That way if the market proceeds to drop in price, the profit from my call spreads helps to offset any profit I give back on my bullish trades.

2. Even if I didn’t have any existing bullish trades, the topping action (slowing momentum & lower pivot high) of the RUT justified entering a bearish trade on its own merits.

Here’s the trade:
RUT June 550-560 call spread
STO 550 Call for $2.85
BTO 560 Call for $1.85
Net Credit = $1.00
Max Reward = $1.00
Max Risk = $9.00
Prob of profit = 90%

Here are a couple risk graphs for the spread.




With this trade, I’m essentially betting the $RUT will not be above 550 at June expiration. With today’s downdraft, the spread is already down to $.50. Once the spread declines to around $.20, I'll close the position to lock in the gain.

Tyler-

8 comments:

Mob said...

Tyler, thanks for sharing - what software are you using to generate the graphs i the post?

krdalal said...

Hi,
I am knew to Options Trading and have been learning a lot from your writings. I have collected and am in the process of studying several books on the subject.
One facet of Options Trading that strikes me is the fact that one needs to make a projection of the TREND; I have been unable to locate a useful Book on the subject.
I am wondering if you could make some suggestions on which Book you have found useful and whether you use Technical Analysis and possibly suggest a Book on TA as well.

Tyler Craig said...

Mob,

I use the EduTrader Software. Their data provider is Esignal.
www.edutradersoftware.com

Rene said...

Great post, thanks for sharing your trading strategies. In particular your ideas on hedging, something I need to work on. One question...how do you calculate the 90% probability of success on this bear call trade? Thanks Tyler!

Tyler Craig said...

Rene,
Glad you're enjoying the blog. I calculated the probability of profit by looking at the delta of the 550 call (the one I sold). The delta was 10, implying a 10% chance the RUT would be above 550. Consequently there is a 90% chance the RUT will be below 550 at expiration.

Tyler-

Tyler Craig said...

krdalal,

You bring up a great point. Whether you're trading stocks, options, futures, or any other financial instrument- TIMING is crucial to success. The better you can become at forecasting the future direction of a stock, the higher your odds of success. There are a ton of books out there on technical analysis and most rehash the same information. I'd recommend "Technical Analysis of the Financial Markets" by John Murphy. It's a beast of a book - taking a comprehensive and exhaustive look at charting. Rather than reading from cover to cover, I would suggest using it as an encyclopedia to consult when you want to learn more about specific price patterns or indicators. Beside the book, www.stockcharts.com has a lot of free info on reading charts that you may find useful.

Tyler-

Charley240 said...

Hi Tyler,

I met your dad recently at a WIA training class. He shared your USO journal with us and told us to look you up. Good advise.
I have a question regarding management of a position in the middle of a trade. ie: Stock xyz Buy jul 18 Call @ 1.45. All indications are the stock will move up. It does for the first day or two but then heads down on bad news. 1 - I can get out and take a loss, or i can manage the trade to minimize losses or even turn the loss into a profit. What would be the best strategy to us and then plan for before entering such a trade in the future.

Tyler Craig said...

Charley,

Thanks for the question & I'm glad you're enjoying the blog. There isn't one right way for managing a long call trade. You just have to decide how tight of a stop you want to have on the position. My original stop loss for long call trades is usually placed under support. Then once the stock hits my target, I would move the stop loss up (perhaps to the prior day's low). Hope that helps