OAP 082: [Case Study] How We Cut The Loss On This Bear Call Credit Spread By 37%

Download The "Ultimate" Options Strategy Guide

We can't control the stock market - yet many of you try to will or hope stocks to move up or down as needed for your position to make money. Eventually, you'll come to realize that it's an impossible dream and the harsh reality of transiting from novice to professional investor requires a more consistent and systematic approach. The question then becomes, "What can I control?" and "How can I adjust or hedge a position that moves against me?"

In today's show, we'll look at one of our recent bear call credit spread trades in which we still lost money, but was able to cut the loss by 37% making some simple trade adjustments. Yes, you heard me right, we're going to do yet another case study on the lessons learned from an options trade that overall, net-net lost money. Unlike many other traders who are afraid to show you losing trades, I'm completely open to them because I know it offers an excellent opportunity to learn and grow from my experience.

Key Points from Today's Show:

  • It is always important to remember that the trade entry is still the most important part of your trading system.
  • Having the right entry, selling option premium, being as neutral as you can, and keeping your position size in check more than covers 95% of the things that will make you a successful trader.
  • However, these adjustments will not save a trade that is bad from the start.

Study Description.

  • The study focuses on SPY, which is a major market ETF that follows and tracks the S&P 500.
  • Entered a bear call credit spread: selling a call and buying call a couple strikes higher, a neutral to a bearish position.
  • Implied volatility was high, around the 70th percentile.
  • When the markets opened up again after the election, it moved against us.
  • Had to take proactive steps to reduce the loss along the way.

Opening Position in SPY.

  • Entered into the December expiration contracts in November.
  • Sold the $215 call and bought the $218 call, which is the bearish call credit spread trade.
  • Collected $95 in credit on that initial position, per spread (5 in total).
  • The initial risk was $205 per spread and $95 of potential profit.

First Adjustment [3 Weeks to Expiration].

  • The first adjustment is to turn the bearish call spread into an iron condor.
  • Sell the corresponding put spread below the market, also $3 wide and the same number of contracts.
  • When you mirror the bearish call credit spread it adds no additional margin or risk to the position.
  • Sold the $213 puts and bought the $210 puts for a $22 credit, which is added to overall premium to reduce risk.
  • Risk gets reduced from $205 to $183 per spread.

Second Adjustment [2 Weeks to Expiration].

  • The market continued to move against us, so we rolled up our short puts from $213 to $218.
  • Collected another premium of $52, which further reduces risk.
  • Risk went down from $183 to $130 per spread.

End Result.

  • Closed out of the call spread side at a $2.99 price, giving a net loss of $129 per spread.
  • This gave an overall 37% reduction in the loss.
  • You do not have control over the market, but you can reduce the loss by making these adjustments.
  • The adjustments saved us $375 across all five contracts.
  • Even though it was a losing trade, it did not lose as big as it would have without the adjustments.

Option Alpha Podcast Show Notes[FREE Download] Podcast Show Notes & Transcript PDF: No time to read the show notes right now? We've made it incredibly easy for you to save time by giving you instant access to the complete digital version of today's show. Click Here to Download Your FREE Copy ?

Free Options Trading Courses:

  • Options Basics [20 Videos]: Whether you're a completely new trader or an experienced trader, you'll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
  • Finding & Placing Trades [26 Videos]: Successful options trading is 100% dependent on your ability to find and enter trades that give you an "edge" in the market. This module helps teach you how to scan properly for and select the best strategies to execute smarter option trades each day.
  • Pricing & Volatility [12 Videos]: This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We'll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
  • Neutral Options Strategies [7 Videos]: The beauty of options is that you can trade the market within a neutral range either up or down. You'll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
  • Bullish Options Strategies [12 Videos]: Naturally everyone wants to make money when the market is heading higher. In this module, we'll show you how to create specific strategies that profit from up trending markets including low IV strategies like calendars, diagonals, covered calls and direction debit spreads.
  • Options Expiration & Assignment [11 Videos]: Our goal is to make sure you understand the logistics of how each process works and the parties involved. If you don’t feel confident in the expiration processes or have questions that you just can't seem to get answered, then this section will help you.
  • Portfolio Management [16 Videos]: When I say "portfolio management" some people automatically assume you need a Masters from MIT to understand the concept and strategies - that is NOT the case. And in this module, you'll see why managing your risk trading options is actually quite simple.
  • Trade Adjustments/Hedges [15 Videos]: In this popular module, we'll give you concrete examples of how you can hedge different options strategies to both reduce potential losses and give yourself an opportunity to profit if things turn around. Plus, we'll help you create an alert system to save time and make it more automatic.
  • Professional Trading [14 Videos]: Honestly, this module isn't just for professional traders; it's for anyone who wants to have eventually options replace some (or all) of their monthly income. Because the reality is that mindset is everything if you truly want to earn a living trading options.

Option Trader Q&A w/ David

Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. This week's question comes from David who asks:

When adjusting iron condors, it is recommended to adjust the unchallenged side. So if the underlying stock goes up, then you roll up the put side. However, if you keep adjusting the unchallenged side, wouldn't it eventually become extremely narrow, becoming an iron butterfly?

Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.

PDF Guides & Checklists:

  • The Ultimate Options Strategy Guide [90 Pages]: Our most popular PDF workbook with detailed options strategy pages categorized by market direction. Read the whole guide in less than 15 mins and have it forever to reference.
  • Earnings Trading Guide [33 Pages]: The ultimate guide to earnings trades including the top things to look for when playing these one-day volatility events, expected move calculations, best strategies to use, adjustments, etc.
  • Implied Volatility (IV) Percentile Rank [3 Pages]: A cool, simple visual tool to help you understand how we should be trading based on the current IV rank of any particular stock and the best strategies for each blocked section of IV.
  • Guide to Trade Size & Allocation [8 Pages]: Helping you figure out exactly how to calculate new position size as well as how much you should be allocating to your each position based on your overall portfolio balance.
  • When to Exit/Manage Trades [7 Pages]: Broken down by option strategy we'll give you concrete guidelines on the best exit points and prices for each trade type to maximize your win rate and profits long-term.
  • 7-Step Trade Entry Checklist [10 Pages]: Our top 7 things you should be double-checking before you enter your next trading. This quick checklist will help keep you out of harms way by making sure you make smarter entries.

Real-Money, LIVE Trading:

  • EWZ Iron Butterfly (Closing Trade): After nearly pinning the stock at our short strikes, and thanks to the volatility drop, we netted a $600 profit on this iron butterfly trade.
  • VXX Short Call (Closing Trade): One of the most consistent and profitable options trades we can make is shorting pure volatility with VXX and today we closed this naked short call in VXX after a couple days for a $420 profit.
  • DIA Iron Condor (Adjusting Trade): This neutral iron condor in DIA is need of a quick adjustment early this week as the market continues to rally. In this video, we'll discuss why I'm adding an additional put credit spread while also choosing NOT to close out of our current put credit spread due to pricing reasons.
  • COP Short Put (Closing Trade): These single short puts in COP acted as a great hedge for our other bearish bets in oil this month and helped smooth out our returns after we closed them for a nice big profit.
  • TSLA Put Debit Spread (Closing Trade): Although many people thought we were crazy for getting bearish in TSLA this pre-earnings put debit spread trade made us $200 today. After the huge run up from $140 to $260 and getting some technical sell signals, we were pretty sure this stock would pull back.
  • MON Iron Condor (Closing Trade): Following a huge drop in implied volatility we worked hard to close this MON iron condor trade adjusting the order multiple times to fill before the end of the day.
  • IBB Call Debit Spread (Opening Trade): We'll show you how I started searching for a new bullish trade and eventually found a low volatility trade in IBB looking for a move higher to hedge our portfolio.
  • TLT Iron Butterfly (Closing Trade): Following the Brexit vote TLT and bonds traded in a nearly $8 range really quickly - even still the drop in implied volatility helped generate a $330 profit for us.
  • XBI Call Debit Spread (Closing Trade): Got lucky picking the exact bottom for our entry in this call debit spread for the XBI biotech ETF which ultimately was closed for a profit of $165 today on the rally higher.
  • COH Iron Butterfly (Earnings Trade): Shortly after the market open we close out of our COH earnings trade for about a $160 profit, leaving just 1 leg on to expire worthless.
  • EWW Debit Spread (Closing Trade): Using some of the technical analysis signals we discovered in our backtesting research, we were able to make a quick $130 profit on this bearish EWW debit spread trade.
  • IBM Iron Condor (Earnings Trade): Shortly after the market opened you'll follow along with me as we watch volatility drop and liquidity come into the market before closing out the position for $250 profit.
  • SLV Short Straddle (Opening Trade): Using our watch list software we decided to continue to add to our existing SLV short straddle position with a new set of strike prices reflective of the move lower in the ETF recently.

Thank You for Listening!

I'm humbled that you took the time out of your day to listen to our show, and I never take that for granted. If you have any tips, suggestions or comments about this episode or topics you'd like to hear me cover, just add your thoughts below in the comment section.

Want automatic updates when new shows go live? Subscribe to the Option Alpha Podcast on iTunes, Google PlaySoundCloud, iHeart Radio or Stitcher right now before you forget - it's fast and easy.

Did You Enjoy the Show?

Please kindly consider taking just 60-seconds to leave an honest Review on iTunes for The Option Alpha Podcast. Ratings and reviews are extremely helpful and greatly appreciated. They do matter in the rankings of the show, and I read each and every one of them!

Also, if you think someone else in your social circle could benefit from the topic covered today, please share the show using the social media buttons you see. This helps spread the word about what we are trying to accomplish here at Option Alpha, and personal referrals like this always have the greatest impact.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.