Trader Weathers Storm for Large Gain
posted 08/14/08 03:45 PM
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Viewed 333 times
Dan Sheridan explains how a trading plan can help one deal with emotions. 
You're as bullish as a matador, so you decide to buy a few calls. To possibly offset some of your gains and reduce your risk, you decide to leg into a long call spread after the stock moves higher. Is this the way to go? Read on to learn more about this trader's state of mind. In a nut shell, the goal of the long call play is for the stock to move sharply and quickly to the upside. For a more in-depth long call lesson, please check out Play #1 of The Options Playbook located in TradeKing's Education Center. The long call spread is a bit more conservative than the long call. To read more, please go to Play #13. THE PLAY - Long Call 
NEXT PLAY - Long Call Spread 
TRADE FORMATION On May 6th Community member Stugots entered the following: Strike A: Bought to open 3 CHK June 60 calls for 1.70 Stock at entry: CHK near 58.00 Maximum gain of long call: theoretically unlimited Maximum loss of long call: debit paid of 1.70 per contract per share Break-even point at expiration: 66.70 (Strike A + debit) On May 20th this trader legged into the long call spread. Strike B: Sold to open 3 CHK June 65 calls at 0.70 Stock at entry: CHK near 59.00 Call spread entry: 1.00 debit Maximum gain of Spread: Strike B - Strike A - spread debit = 70 - 65 - 1 = 4.00 Maximum loss of Long Call Spread: spread debit paid of 1.00 per contract per share Break-even point at expiration: 66.00 (Strike A + spread debit) On May 21st Stugots legged out of the long call spread. Strike B: Bought to close 3 CHK June 65 calls for 0.50 Stock at exit: CHK near 57.00 Short call result: 0.20 profit (less transaction costs) Long call basis: 1.70 - 0.20 (short call profit) = 1.50 debit Maximum gain of resulting long call position: theoretically unlimited Maximum loss of resulting long call position = debit of 1.50 per contract per share Break-even point at expiration: 66.50 (Strike A + net debit) On June 18th this Community member liquidated part of his position. Strike A: Sold to close 1 CHK June 65 call for 5.10 Stock at exit: CHK near 66.00 Long call result on 1 of 3 contracts: 5.10 - 1.50 = 3.60 (less transaction costs) 3.60 / 1.70 = 211% ROI in 44 days for one-third of position* (entire debit used for most conservative ROI calculation) On June 19th Stugots exited his remaining calls. Strike A: Sold to close 2 CHK June 65 calls for 5.00 Stock at exit: CHK near 64.00 Long call result on 2 of 3 contracts: 5.00 - 1.50 - 3.50 (less transaction costs) 3.50 / 1.70 = 205% ROI in 45 days for two-thirds of position* (entire debit used for most conservative ROI calculation) *NOTE: This return represents past performance and does not guarantee future results. ALL-STAR COMMENTARY May 6 Stugots bought 3 Jun 60 calls at 1.70 with CHK at around $58. He comments he was "shooting for the moon," but if CHK goes higher, he would sell the Jun 65 calls to leg into the bull call spread. Dan's two cents On May 6, CHK stock was up big, almost $2 to $58. This is up from $53 on May 29. The train was leaving the station and Stugots was going along for the ride. Call implied volatility was around 35 on May 6, which was in the middle end of the range for 2008. The Jun 60-65 bull call spread for $1 looked pretty good, but with Stugots " shooting for the moon" the long calls weren't a bad idea. If he really had a strong conviction on the upside, he could have gone a bit in the money and bought the Jun 55 calls near the $4 range. May 20 Stugots sold 3 Jun 65 calls for .70, said he was "setting up the 60-65 bull call spread for $1." Dan's two cents Stugots initial statement on May 6 ("shooting for the moon") coupled with selling the Jun 65 calls for .70 didn't jive. He ended up getting into the bull call spread for $1. It was around $1.10 on the day he bought the calls. The stock on May 20 (two weeks after he bought the calls) was only trading about .60 higher. It appears he was getting a bit impatient. CHK didn't move yet and he wanted to get something for a hedge. He was hearing foot steps! Two weeks for a momentum guy - shooting for the sky and no results - is a long time! May 21 The day after he sold 3 Jun 65 calls for .70 to turn his long calls into a bull call spread. Dan's two cents He scalped his short calls for .20, buying in 3 Jun 65 calls for .50. His mentioning "quick buck", seems like a bit of a day-trader mentality. It doesn't seem like he had a clear plan and was winging it a bit. My hat goes off to him for sticking with his conviction though. As of May 21 he basically hasn't made any dough yet, but has been in this trade over two weeks. He's not bailing yet, but I'm sure he's getting more impatient. June 18 He sold to close 1 CHK June 60 call for 5.10 saying "that covers my cost of the three I bought at 1.70." He still holds 2 long June 60 calls. Dan's two cents Very interesting! He's looking good now but went through some dark, dark days (see chart below). Almost one month transpired from the last trade where he bought in his short calls. On Wednesday, June 4, CHK closed around 53.73. His Jun 60 calls that he bought for 1.70 were trading around .30. At this point I have Stugots down around $368 and he's not even blinking. A Real Cowboy! This shows me Stugots' plan that if the trade went against him, he was to strap himself in and hope for the best. This type of risk management for speculative trades could spell disaster in the long run. How many trades can you afford to go through and lose everything? This was the low point; almost a month into the trade and the stock was down from where he bought it. From this point on the stock ran up hard and Stugots looked great! 
Click here for a larger chart. June 19 He sold out his remaining 2 long calls for $5 and was declared the victor Dan's final two cents Here are my concluding remarks. Stugots doesn't rattle quickly. If I go into battle and things get ugly I want Stugots by my side. On the other hand, at this point I don't want him managing the entire battle yet. To succeed long term in the spec game, some type of downside plan other than hold on for the ride is necessary. I would like to see him get much more comfortable with spreads before he hedges his long calls again. I would rather that he sticks with trading long calls at this point. He legged into the call spread for only about .10 better than he could have bought it on day 1. His buying back of his short calls was genius because of the way the trade progressed, but scalping calls for .20 doesn't make sense for speculative trades long term. In summary, I salute you Stugots! I challenge you to work on a plan for your speculative trades and strengthen your spread trading. Your instincts are very good my friend! --Dan Sheridan Owner and Mentor Sheridan Mentoring All-Star Commentator For a list of previous All-Star Trades, please click here. Would you like your Trade Note to be chosen? Read more. This comment and any market data included here were prepared on 6/25/08. Nicole Wachs contributed to this blog. Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options. The return on these trades represent past performance and does not guarantee future results. While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct. Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs. Dan Sheridan has a professional business relationship with TradeKing.
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