Lesson Overview

SLV Call Debit Spread

You've heard us before talk about why we don't use stop loss orders especially on risk-defined trades like debit spread. In today's video case study we'll look back at a trade we placed back in April and rolled 2 times to extend the trading timeline before turning a small profit. Moreover, you'll see why a stop loss order would have actually prevented you from making money in SLV these past 2 months.

Show Video Transcript +

Welcome back to the video recap for all of our trades on Thursday, June 19th. And I want to go over tonight the opening trade that we had in CVX which I’ve been waiting for, for quite a long time now.

And actually, I guess patience in this instance worked to our advantage because the stock just continued to move higher and higher and higher and I think it’s one that surprised for a little bit of a turnover.

And then I also want to cover our closing trade in SLV and X which is US Steel. I first want to start out with SLV. This is a really interesting trade and one that we’ve had for quite a long time.

It’s been through two contract months of rolling, so we rolled it from May to June and now June to July just last week. And finally today, we start to see a big move up in silver and silver popped higher along with gold and some of the other metals and just gave us an opportunity to close out this trade after two rolls and three months of working at a nice profit.

We closed out the trade at about a $75 profit overall which doesn’t seem like a lot, but for this trade, it’s really great because it showcases why rolling contracts to the next month, in this case, can be profitable if you do it the right way.

And in this case with the debit spread originally, we rolled each contract to the new month and did not pay a lot of money to extend our trade. In most cases, we were paying $5 or less to extend the trade from May to June and June to July.

Paying that extra money really benefited us because we were able to hold the position a lot longer for a little cheap price each month and that gave us finally an opportunity to make some money.

And this only really works if you’re able to do that with a cheap roll, so not paying a lot to roll your contracts which I see a lot of new beginning traders do, is paid to roll their contracts which don't help, and if you still have the same underlying assumption for your trade.

In this case, we’ve still been bullish on silver this whole time and the stock just really hadn't gone above 19 which is our breakeven point until today when it had a huge pop up higher.

We went ahead and sold back to the market our July 18/20 debit call spread that we had originally entered, so we sold that back for a 141 credit today and took in a $26 profit after all the rolls in silver.

Here’s a chart of silver. And you can obviously see that for the better part of the last two months; the stock has stayed pretty much right underneath or right at our breakeven price of 19.

Remember, we traded the 18/20 spread, and we originally bought it for about $1.5 or so, so that put our breakeven price right around 19. You can see that most of the time that we were trading this stock, the stock was actually in or out of the money from our strikes, meaning that we were losing all but the last couple of days here.

We had a completely losing trade, and we just kept extending our duration, extending the time of our trade from this month to this month to this month and then finally, out to this month if we needed it. But you can see that silver popped much higher today which obviously gave us a huge opportunity to make a profit.

Now, your normal trader would just take a loss on this trade. They would just leave this trade on and say, “You know what? My breakeven is at 19.” And every month, they would take a loss.

And maybe if they reentered it, they’d take another loss again maybe here and get out of the position using those stop orders. That just helps you lose more money with stops.

But a stop order or in this case, just a regular trader might have gotten out of this position whereas we just extended the duration in our position, pushed it out another contract month every single time.

We remained bullish on silver overall, and at some point, we got that pop higher that we expected and wanted to make a profit in this position.

If we didn't get that move higher today, we had all the way until July expiration at about the same price to see a good move up in silver. And we had a nice run in silver here, so it gave us a great opportunity to get out of the trade.

The other position that we got out of today was X which is US Steel. No, this is not a typo in the trading alert today. We sold back all of our 23/25 debit call spreads in US Steel, took in a nice credit of 145 on all of those, so a nice $43 profit on each of those, a very, very profitable position for July expiration and got out of it early.

This is a directional trade that we made, so we keep our position size very small, but we had a nice move in US Steel basically from the bottom when we entered it. I think we entered it somewhere around here or so and had a nice run-up in the stock.

Implied volatility hasn’t dropped all too much as the stock has gone up, but that's okay because we had a nice move up in the underlying stock way past our breakeven point, so it gave us a huge opportunity to take some money off the table.

At this point, we have between now and expiration. All the way out in June, there is a likelihood that the stock could turn all the way back around. This was originally a low probability bet; it was more of a directional trade to stay active in the market during this low volatility time.,

So we wanted to take advantage of whatever the market gives us at this point by exiting this trade. Alright, the last trade we want to go over tonight is CVX. With CVX, we did a very simple debit put spread. All of these are debit spreads that we’re working with, we’re not selling options.

In this case, we are taking a directional bet in CVX for July, so we traded the July contracts, and our strikes are about $10 wide. It’s a fairly wide strike that we entered, and it was the 135/125 debit put spread.

We bought the 135 option which is in the money and then we sold against that option the 125 option which is just out of the money. Now, we usually like to pay about mid-price of the width of the strikes.

In this case, the width of the strikes is $10. That means that we want to pay about $5 or so and you can say we paid just below that at 4.56. Now, I’ll go over in a second after we go over the chart here why we entered the spread with a $10 wide strike instead of a $5 or a $7.5, whatever the case is. We’ll go over that here in a second.

But generally speaking, this is why we entered the debit spread for CVX, and that’s because CVX and oil had had a monstrous run-up in the stock. And you can see just a huge, huge run-up in the underlying security over the last week and a half or so.

And you’ll notice that there’s one, two, three, four, five, six, seven, eight, nine, ten, almost eleven days straight up in a row on the stock.

And when it typically has this type of move, it does one of two things – Either it stalls out, so it had this very similar type of move back in April, and then it just stalled out and started to trickle over, or in our case, we like to see just a quick move down, just a mini-correction here, give us a quick opportunity to make some money in this trade.

That’s ideally what we like to see. But regardless, the reason that we traded it directionally bearish is that of this huge move. We know that a stock cannot sustain this type of move indefinitely.

It’s got to market correctly at some point, and people are going to take money off the table. Now, the reason that we chose the strategy we did is that implied volatility is low, so it’s not above the 50th percentile that we like for selling option strategies.

We’re not selling a credit spread or a put spread or an iron condor here, we just only have a couple of different options, and that’s a calendar or a ratio spread. In our case, we just worked with a simple directional put spread.

Now, if we go to the actual pricing grid here of CVX, you’ll notice that the pricing on this one was a little bit different today. And what we wanted to do was match up our underlying price with mid-price of where the stock is trading right now.

I’ll mimic exactly what we did here where we bought the 135 and sold the 125. Right now, that’s trading for 343, so we lost a little bit of money there, and that’s okay, it’s just a directional move on the day.

But ideally, what you want to do is you want to get your breakeven price as close to the price of the underlying security as possible. In this case, if we entered this trade right now at the current price which is not what we would do, but just for the sake of argument here, our breakeven price would be 131.57.

Now, you'll notice that the stock is trading at 132. What this means is that since you’re trading this bearish and you want the stock to fall, you need the stock to fall from 132 to 131.57 before you even begin to start making money at expiration.

You are already putting yourself at a disadvantage by trading the security this way. By making the spread wide, you force the market to make one directional move before you even begin to start making money on this trade.

I’d like to see that breakeven point a little bit higher than it is right now, if not, at the stock price higher than the stock price currently is. We’ll do something here. Well, let’s just expand out this trade here and just walk through some of the things that we would look at.

If you did something like a 140/130 strike, this maybe a little bit different, maybe a little bit better pricing than you see here. And you can see you get a breakeven price that’s higher than the actual stock is trading at right now.

But as far as the money that you’re risking versus your max profit, it's not ideal in this situation; you’d more like it to be 1:1. By the time that we entered this trade today where we had our strikes and where CVX was trading at the time, our breakeven price was above the market at that time.

Now, the stock has rallied up today, continued to rally up today, so we’re losing about $113 overall in the position today. But it was a one-day move, we still definitely expect the stock to move down further over the course of the next month or so as hopefully oil continues to correct, and people start to take profits on this trade.

As always, I hope you guys enjoy these videos. If you have any comments or questions, please ask them right below here. I’ll get back to all of those tonight or tomorrow before the open. And happy trading!

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