How We Cut the Loss on this Bear Call Credit Spread by 37%

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'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.