32 weekly Trade Alerts issued. 25 Trade Alerts closed for a profit with 7 still open. Only 1 of those 7 went against expectations. That’s our record at Stock & Option Trades.
While most would try to shove that 1 trade under the rug and ignore it, we recognize that surprises happen in the market and we have a plan to deal with such surprises. So, we were delighted when Phil offered us the opportunity to present the 1 trade that went against us in the last 6 months and spotlight how we have saved it.
On the week of September 16th, anticipation was reaching fever point as the Federal Reserve was due to announce its decision on rate cuts. Moreover, Bear Stearns, Goldman Sachs and Morgan Stanley were due to announce earnings reports. With such palpable excitement in the air we felt that we would certainly see volatility in the prices of the aforementioned stocks. And, we had a double-shot at benefiting from such volatility. If the rate cut didn’t cause a move, surely earnings would.
We decided that Bear Stearns, being the weakest of the companies, would be most likely to react most violently. We believed its volatility would be greatest and sought out a trade that would take advantage of the expected big moves.
With same confidence that had led to our previous 6 months of winners, we entered our trade, a Ratio Put Backspread. Along with our target goals, our risk management section and indeed our fundamental and technical analysis sections we highlighted the following in our Trade Alert.
- Sell To Open September Short Put Strike $125 (symbol: .BSCUE – Bid: $9.40)
- Buy To Open September Long Put Strike $120 (symbol: .BSCUD – Ask: $6.10)
- Buy To Open September Long Put Strike $110 (symbol: .BVDUB – Ask: $1.95)
Essentially, we needed the stock to move up or down by $10 to make our return during the week.
As the week came to a close Goldman Sachs had vaulted higher by almost $15 but Bear Stearns had astonishingly ended flat! Needless to say our existing trade was not looking nearly as great as we had expected. The stock had gone up during the week and it had gone down during the week, but in the end, which is what counted, it was the same place it began the week!
If we were like most traders, we may well have taken a loss at this point. After all, that is how most trade the stock market – they enjoy winners when guessing right while accepting losses when guessing wrong! But not at Stock & Option Trades! We believe that if you keep taking losses, there is a BIG chance that you will end the year at a loss! However, if you can turn every trade that goes against you into a winning trade, then each year will be a winning year! Simple but powerful!
While many different modifications were possible, we chose to convert our Ratio Put Backspread into a Covered Call. We took assignment of our short put and bought the stock at $125 per share. (Of course, this was offset to a degree by our short put premium, $9.40). We also captured remaining intrinsic value in our September long put at strike 120.
We then took a proactive approach to generating income and entered a short call in November near-the-money at strike 115. Our net cost following all transactions was a few dollars under $115.
We take the same approach as Phil does when a trade goes in the opposite direction to that which was expected – we try to get our money back! It’s no time to play the hero and seek big winners until the original capital is back in our pockets. And the way we structured the trade, we ensured we would pocket a few dollars per share of profit also upon assignment in November. (With the stock trading around $131 per share, this is looking very likely!)
The modification was simple and straightforward but few practice this type of trading. In practice, this approach tests a key tenet of trading success; having a plan and sticking to it!
Our mission is to educate our members through example and while we hate seeing trades move against us initially as much as the next trader, sometimes the best education comes from the surprises the market throws us. If you have a system that works for you, stick with it! And if you don’t, make sure to find one that works because as Phil said in comments this week “Down is possible too!” and you don’t want to be left standing when the music stops. At Stock & Option Trades and Phil’s Stock World we apply systems that evolve with the market that have worked over time for us. Make sure you too are making money!!
Wishing you a fantastic weekend!
Stock & Option Trades
