Just like a NASA countdown we are waiting patiently for lift off or actually putting this strategy into play. As I promised last week we are going to go into the market and see if we can’t find a candidate that will fit our needs for this trade and then throw that trade on in a paper account and follow it along to see how this great trade really plays out.

First, I will reiterate what we are looking for in this kind of trade. The back-ratio spread needs movement to be effective. The direction is less important than the magnitude. Of course, we would prefer movement in our chosen direction but adverse movement is not the end of the world because as you saw a couple of weeks ago that sometimes we have a credit for the trade in which case adverse movement would result in a small win anyway and the even with a debit trade our risk is defined and if we accept this risk before the trade starts and we position size correctly then it shouldn’t cause a meltdown in our portfolio. As I stated last week, this like any other trade does have risk and the risk here is the stock goes no where and pins at the long strike price. At expiration, this is where the most risk lies and this is a danger zone that we must protect against.

In the video below you can see all the parameters that we use to put on this type of trade on but there are some other things to consider. We talked about time last week and we definitely need more time than less time. This could sometimes make doing this trade somewhat difficult if you are going out in time and seeing only wide strike prices. You may find that you need to pass on a particular trade if the reward to risk is not in line with you trading expectations. The other thing that comes into play is the volatility. Since we are selling one and buying two the effect of volatility is somewhat muted but we are buying twice as many as we are selling there will be some effect. At this point in time in the overall markets, volatility is on the lower end of the scale and this presents an opportunity to let volatility work for us in this trade.

In the video, we go through a mock trade on AAL and we will follow this trade and make adjustments as necessary. We will see the inner workings of this trade and see where it can fit into our trading plan.

Happy Trading All!

Coach Holmes