Another addition of the Morning Mailbag!  Here we answer Tackle Trading Team members questions about anything!  Feel free to tweet us @tackletrading or myself directly @timjusticeutah and ask us a question, post in our Club House or email us directly @ team@tackletrading.com

Hi Tim,

 

I have MDU stock bought  31.01 $.

MDU has been uptrend but major pivot in May

reversing (is it a retracement or trend,

can’t assess, maybe indicating dw trend

for a while ?). Anyways my question is:

 

I think I should get out, but before I do,

could I practice Legging into Covered Call –

selling an ITM call, to recoup loss ?(as we

learned in CF Options class)

 

31.01 dropped to 29.40 current mkt.

Oct 14  , 25 STRIKE for 3.50 available , but MachT shows no

volume (? my MachT III is not the best, maybe TOS

has a volume column, I know you showed us today

how to get the Greeks columns, but went too fast for my brain,

could not fix the info, so I have to wait for the recording

to be able to start implementing). If I did the transaction,

is it a Single entry ?

 

I picked wrong trade of course, but in this position

what would you do ?

Ulrika

 ______

Ulrika,

Thanks for the question.  There are a few bits in your analysis I want to address.  MDU is most definitely in a downtrend.  A sequence of lower lows and lower highs from May until now are more than enough confirmation that a downtrend exists.

Legging into a covered call from a stock position is a creative and smart thing to do.  But, you should only do it if you want to hold the stock intermediate or long term and if you believe the stock is not going to drop and stay in a downtrend from here.  Selling a 25 strike in the money is not the best choice if you’re trying to generate any cash flow though because that strike has little to no extrinsic time value.

If a new trader found themselves in a complicated position they didn’t plan on being in to begin with I would generally counsel them to exit the position and start over with something new.  ‘Fixing’ trades is something to consider – but better left for experienced traders who have a good grasp of how to use the risk graph and assess option prices.

_________________

Tim, I setup the trade below using the Bear call spread (Credit).

Using the Bear call spread strategy:

1.Sell less than six Weeks: In this option 4 weeks

2.Delta below .25 on both legs.   My select .21 and .03.

 

To my understanding, as long the stock stays below my Strike Price 28, I’ll continue to earn profit.

After taking a deeper look, because the Buy Strike is at 35  I notice that I’m risking a lot money.

 My question is how could I lower my risk in regard to the dollar.

 What I’m seeing is to place  a Buy Stop Limit order at the  30 strike……to reduce my Risk .

 I’m trying to really understand this strategy……I’m focusing to identify each strategy and which scenario  how to  use them.

 Chris

Chris,

In this example you’re attempting to sell a 30 strike call and buy a 35 strike call in the same expiration month, with low delta’s that have 4 weeks of time until expiration.  This is a classic Bear Call spread and a strategy that you should work on to perfect and use in your trading system.

Credit spreads, when built with low delta’s, will generally have more risk than reward.  It’s not uncommon to have 400 or 450 risk for only 100 or 50 of reward for a vertical credit spreads.  Traders are willing to accept that reality because the use of low delta’s .  Low delta credit spreads represent high probability of success.  The logic goes something like this: “I’m willing to risk 400 to make 100 because I’m going to be right 80 to 90% of the time”.  The end result is dependent on the traders ability to make good choices, identify good credits and manage the 10 to 20 % of the trades that don’t work.

To lower your risk in a spread, you could buy a lower strike.  If there is a 32.50 strike available you could use it instead of the 35.00 strike.

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