Today’s tale details how I clinched victory from the jaws of defeat. Within you will also learn of how I employed the scaling-in technique with a credit spread.

October’s bloodbath had me in a bearish mood. Reasoning that support levels, now broken, would become resistance I adopted a “sell the rally” posture. Furthermore, with the weakness so persistent I was anxious to pounce on strength quickly lest it disappears before I could deploy a bearish trade.

Unfortunately, my eagerness resulted in pulling the trigger too swiftly on a bear call spread in Caterpillar (CAT).

On November 1st, CAT was working on the third day of a bear retracement. Its morning up gap was swiftly rejected at the earnings gap area which I knew could become a new resistance level. So, with the stock at $122 I sold a Dec $135/$140 bear call spread for 76 cents. As I usually do, I started with a small position thus allowing myself to add a second or third tier should CAT misbehave and rally further before finally moving in the originally forecasted direction.

Fast forward one day to Nov 2nd. CAT officially filled its earnings gap ending with a spinning top candle. Furthermore, the bear call value had risen almost 50% from 75 cents to $1.07. I went ahead and deployed tier two for $1.07.

To be clear, I now have two batches of Dec $135/$140 bear calls entered at 76 cents and $1.07 respectively. At this stage, I’m hoping a turn lower is imminent.

Does CAT oblige?

No.

She turned the thumb screws one more rotation. The post-election rally was particularly worrisome. CAT pole-vaulted to my short strike in a nasty test of my resolve. With a heap of overhead resistance still in play and the stock now even more overbought I went ahead and entered the third tier for $1.78.

To summarize:

Tier 1: Dec $135/$140 bear call @ 76 cents on Nov 1st.

Tier 2: Dec $135/$140 bear call @ $1.07 on Nov 2nd.

Tier 3: Dec $135/$140 bear call @ $1.78 on Nov 7th.

At this point, I’m in a full position and out of ammo. If CAT continues to power higher uninterrupted, I have to resort to other tactics or simply take a loss. Fortunately, it finally succumbed to gravity allowing me to peel off my positions in breakevenish territory. If you pull up a chart of Caterpillar you will discover it dropped over the next three trading sessions. The bear call value fell back down to just under $1.00 in the process.

Now come the exits.

I exited tier 3 at $1.28 locking in a 50 cent gain on that piece.

I exited tier 2 at $1.20 locking in a 13 cent loss on that piece.

Still holding tier 1.

Want to learn more about the scaling-in concept? Check out these other articles:
How to Make Trade Timing Irrelevant
How I Played the Bond Bomb
The Lost Art of Scaling