As promised, I want to share a trade with you from my new membership site. Most folks would show you a trade that has worked out wonderfully well, producing significant profits. I am not going to do that in this post.
Instead, allow me to show you a trade that has not worked out according to plan. This stock option trade was opened as a double diagonal spread on Starbucks, Inc. (SBUX), following their earnings announcement. My opening position consisted of a long July call and put, with June options sold against both, as follows:
BTO July Call 35
BTO July Put 27.50
STO June Call 32.50
STO June Put 30
For a .50
CREDITWaiting for earnings to be released avoided a subsequent drop in the implied volatility of this position, which is a risk with double diagonals. The one other risk is a directional move outside of the break even points. Above, you can see a price chart with the break even points displayed as two red horizontal lines.
There is a double bottom visible on the chart, which is a bullish sign. The earnings news had not been bad, but there apparently remains a good deal of concern that SBUX will not be able to continuing growing its business at a pace sufficient to push the stock price higher. This could be good news for a range bound strategy, such as this double diagonal. However, if investors sell the stock to look for green pastures we could see it break through support.
Today, SBUX was looking weak. While it had not violated the price channel signified by those red horizontal lines, the gamma for this position is fairly high. A high gamma is not a good thing if the share price is near the strike of your short option. The bottom line is that my comfort level with the stock has waned and rather than tempt fate, the position was adjusted this morning to accommodate the perceived weakness in the stock's price.
The adjustment was simple. I simply closed the put diagonal portion of the double diagonal spread. The trade was executed for a .50 debit. That closing debit offset the prior credit, so I now own a call diagonal spread for no cost. The risk graph of the new position is posted below.
The green line represents the value of my options position as of the June expiration date. The white line represents the current position value. The horizontal, dashed white line represents break even. You can see that SBUX can lose all value and I will still see a small profit on the trade.
The important thing is that the downside risk is completely eliminated.
This is important! You can open 10 trades each month. Some will make money. Some will lose money. The trick is to lose as little money as possible when trades don't work out for you. Staying in a losing position "hoping" things turn around is a loser's game.
Now, if SBUX heads higher I can lose money on the call side. However, I already have a trading plan in place that will deal with that possibility. In fact, even though this trade has not worked out as originally envisioned, I still don't plan on losing money on it. I can't tell you how much, but this "loser" may still put some cash in the account before summer begins.
Too many options trading services harp on their big winners. I have a "dirty little secret" that I will share with you. The professional traders don't stand around on the exchange floors talking about returns. They talk about managing risk.
You see, the real "holy grail" of trading is not about the big wins. The big winning trades are nice and we all like them, but they're not what keep you in the black. Knowing how to reduce loses, manage risk, and keep yourself from suffering the big loss is how the game is won.
With that in mind, I decided to share with you one of my trades that was not working out real well. The several other trades I opened earlier this month are all looking good and I just opened a new position on Apple, Inc. (AAPL) today. All of the positions are fully documented on the private membership site with trade alerts having been issued before I placed any trade.
Good trading!
Christopher Smith
TheOptionClub.com
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