Good Day Rookie Bloggers!

So, we are seeing a rebound in the markets??  We talked about this in the previous blog and how this can be very deceiving and that we must exercise caution in getting too long or too short in too quick of a hurry.  This is the crux of trading, when to jump in or when to sit on the sidelines?  A famous quote is “you got to know when to hold em and you got to know when to fold em!”  This is so true in trading as well.  However, there are times in the markets that even when things look their bleakest there can be good things on the horizon.  In the following dialogue, I am going to walk through a trade that went from very bad to better in a short period of time and I will do my best to explain how these opportunities arise and moreover why we need to see all our trades from various angles if we really want to get the most out of our trading experience and create the best opportunities as well.

The trade I am referring to from above is one that from the onset of the initial trade looked like a sure-fire winner and quickly reversed to come in as a big loser.  This trade started out as many trades do and meandered into profitable territory but then as luck would have it the markets made an about face and those aforementioned paper profits disappeared faster than the money that D.B Cooper got from the hijacking of a plane.  This particular trade is one that a lot of you may be familiar with but the setup might be a little different than what you are used to as the rules used for this trade are slightly different than the ones we often preach about here at Tackle.  I am talking about doing a naked put trade.  Now, usually, when we discuss naked puts from a Tackle perspective we often look for lower dollar stocks and go OTM usually around a 20 Delta to give us a high percentage that our trade will come in as expected.  We often talk about using longer dated puts, perhaps 1 to 3 months in time.  This setup usually makes for a higher percentage of credit collection than say going closer to the money.  This is a very good way to do puts but it is not the only way to do naked puts.  The trade I am referring to from above had a shorter term perspective on a higher dollar stock with the put being reasonably far OTM.  This was a two-week naked put that was at about a 10 Delta.  There was a good chance to collect on this setup, however as we know the markets don’t always care about the odds and probabilities and thus the reason for good position sizing which we have talked about many times before in this blog.

The exact parameters of this trade were as such, the stock was trading above the $145 level and the put that was sold was the $131.  There were two weeks before expiration and the stock had a nice solid support level right at the $135 price point.  This trade looked like a dandy.  After the initial trade went on the stock actually started to move up and was making some nice paper profits and then it had an approximately $9 drop in one trading session.  Now, before I go any further let me say that exit plans were in place before the trade went on as there should be every time!!!  The exit plan for this trade was to take possession of the stock should it fall.  The company has been doing well as of late and it was one that taking ownership of would not be a bad thing.  One other thing that I must say before moving on is that using naked puts on high dollar stock has a tendency to eat up margin quite a bit and to offset this one can turn their trade into a very wide bull put spread and save a bunch of margin for other trades which is what was done in this case.  This trade acted like a naked put but in actual fact was a $131/$122 bull put spread for just pennies less in credit than the straight naked put would have paid out.

Let’s fast forward here a bit now that we know the initial setup.  The stock dropped to $121 on the day of expiration and thus the stock was assigned at the $131 price tag but was now only worth $121ish.  Anyone who has ever had a wide OTM credit spread go against them knows that the pain of one these on the bankroll can be tremendous.  It is not fun, to say the least, even if you have prepared yourself for this eventually from the onset.  So, now the question becomes what comes next now they we are sitting here with shares that are grossly undervalued?  Well, one can look at the chart and hope that the stock returns to glory.  Or one can look for other avenues and angles to see if there is a play that can help recover from this beatdown?  The chart showed no real hope, the price was consolidating sideways around the $122 mark and it showed no signs of life.  So, what else can we try?  Well, as most of you know we are big fans of creating cash flow here at Tackle and one of our favorite ways to do that is by selling covered calls.  This is where the gift part comes in.  With the dropping of the price of this stock the implied volatility skyrocketed and even more so because earnings are quickly approaching and that means the credits in the calls were especially juicy.  Looking at the option chain, it was discovered that the $124 call option was paying over $7 in premium, WHAT!?  Yes, so that means that this newly acquired stock could be promised to someone else for $124 and they were willing to pay $7 plus for that right?  Yes, indeed. 🙂  What this means in terms of math is that the stock that put to us at $131 could be sold for $124 plus the premium and put one back into the black or at worst break even.  In actual terms, this trade was a success because the initial credit spread provided some premium as well.   This definitely feels like a gift but maybe it’s more about being vigilant about looking for all the ways that one can be successful in trading and putting in the effort to learn the many ways that the market can provide as long as one is willing to learn and to search.

I believe there is an old saying that goes something like this….”Seek and thou shall find”  This holds true in trading as it does in life and both trading and life bring gifts to those that are dilligent in searching for those gifts.

Trade Well Friends,