REAL-WORLD TRADING: The Bear Call Spread During Earnings Season, Part IV
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August 11, 2005
We have been following and discussing a mock trade using a bear call spread for the past month and it is now time to wrap it up. Expiration is next week, but the stock is well above its breakeven point so we will finish up our discussion on this trade. Our initial thought was that oil stocks had risen sharply and that earnings news would result in selling. However, this proved to be incorrect, as oil prices decided to move to record highs, taking oil companies along for the ride. The strategy we chose to use was a bear call spread, which is a credit spread. Our max risk on the trade was $750 with a possible reward of $500. Below is the week-to-week data for this mock trade:
June 19, 2005
COP @ $60.57
Buy 5 Jul 62.50 calls @ 1.05
Sell 5 Jul 60 calls @ 2.05
Total Credit = $500
Max Risk = $750
Max Reward = $500
Breakeven = $61.00
June 27, 2005
COP @ $62.17
5 Aug 62.50 calls @ 1.40 (Sell)
5 Aug 60 calls @ 3.00 (Buy)
Total Credit = $500
Current Loss = $300
Max Risk = $750
Max Reward = $500
Breakeven = $61.00
July 19, 2005
COP @ $60.57
Buy 5 Aug 62.50 calls @ 1.05
Sell 5 Aug 60 calls @ 2.05
Total Credit = $500
Max Risk = $750
Max Reward = $500
Breakeven = $61.00
July 27, 2005
COP @ $62.17
5 Aug 62.50 calls @ 1.40 (Sell)
5 Aug 60 calls @ 3.00 (Buy)
Total Credit = $500
Current Loss = $300
Max Risk = $750
Max Reward = $500
Breakeven = $61.00
August 2, 2005
COP @ $64.38
5 Aug 62.50 calls @ 2.45 (Sell)
5 Aug 60 calls @ 4.60 (Buy)
Initial Credit = $500
Cost to Exit = $1075
Current Loss = $575
Max Risk = $750
Max Reward = $500
Breakeven = $61.00
August 10, 2005
COP @ $65.64
5 Aug 62.50 calls @ 3.40 (Sell)
5 Aug 60 calls @ 5.80 (Buy)
Initial Credit = $500
Cost to Exit = $1200
Current Loss = $700
Max Risk = $750
Max Reward = $500
Breakeven = $61.00
At the time we started to follow this trade on COP, the stock was below our breakeven. This meant we only needed the stock to stay flat or decline to profit. This didn’t happen and the trade turned negative on us. As we mentioned last week, most traders would have probably exited this trade sometime after the stock rose and the trade started to lose money. We continued to track the trade so that we could discuss the strategy a little longer.
There is still a chance the stock could move back below $61 by expiration, but this is not likely. It seems that oil prices are going to remain elevated and this continues to benefit oil companies. We have to remember as traders that we are going to have losing trades, but the key is to cut the losses short and let our profits run. There are a couple of ways a stop loss could be determined, so let’s look at these options.
When setting up a stop loss, we can chose to exit when the stock reaches a certain point or when the loss of the trade hits our exit point. We suggest that both should still be mental stops, but a hard stop can be used. For example, we might set a stop loss in this trade at $61.50, which would have been 50-cents above our breakeven point. If this is our exit point, we would exit at whatever price the options are offering. The other way would be to say that we will exit when our loss is say $250.
When trading options, it is wise to have our profit and stop losses set up in advance so that we don’t let our emotions get in the way. Sure, we will see trades gain more after we sell, but we also will avoid letting profits turn to losses. At the same time, we need to get out of losing trades with minor losses so that we can use our capital on more profitable trades. In two weeks we will start a new series so please post any ideas to my forum and I’ll choose one to talk about.
To read previous installments of Real-World Trading, please click here.
Jody Osborne
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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