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This week, we will put into action what we’ve discussed so far about vertical spreads. On Monday, September 19, we’ll open two vertical credit spreads, one bearish and one bullish, applying the criteria we’ve discussed for choosing the underlying and the contracts making up the spread. We will than track these trades throughout their lifecycle, and discuss the rationale behind decisions we make regarding management of the trade. All will be recorded here as updates to this post.
We may make a profit or suffer a loss on these trades. Our goal, of course, is that these trades profit. But if they don’t return a profit, we want to minimize the loss they suffer. Profit or loss, here’s an opportunity to gain insights.
Monday, 9-19-22. I decided to open three bull and three bear trades instead of a just one of each. To make things a little more interesting, I decided to trade three different issues, Adobe, McDonalds, and Morgan Stanley. I entered the trades with consideration of the criteria discussed in earlier posts. Here are images of their profiles.
The table below shows the max risks and gains for each vertical spread. The ADBE and MCD spreads expire on 9-23-22. MS spreads expire on 9-30-22.
Spread | Max Risk | Max Gain | |
ADBE Call | 202 | 48 | |
ADBE Put | 170 | 80 | |
MCD Call | 216 | 34 | |
MCD Put | 205 | 45 | |
MS Call | 166 | 33 | |
MS Put | 169 | 30 |
Many will recognize the profile images to be those of iron condors, which have been constructed by pairing an OTM bull put spread with an OTM bear call spread. The short leg of each spread was selected close to a delta of 25. In all cases, I judged that an area of weak support or resistance complimented the break-even points. The percentages indicate the likelihood of the trade closing in each of the three segments associated with the trade.The blue dashed vertical lines indicate the break-even points for each of the spreads making up the iron condor. I prefer to manage an iron condor as two separate trades and establish separate exit points for each spread. The profit level is 80% of max profit. The exit to minimize loss is at the break-even point. I implemented the exit plans by construction an OCO order pair for each spread. The profit order for each OCO pair is 80% of the pair’s credit. The exit for loss is an order to sell the spread at market price if the underlying reaches the break-even point. The table below summarizes the exits points for each trade.
ADBE | MCD | MS | |||
Call Profit | $0.16 | $0.07 | $0.06 | ||
Call Loss | MKT> $310.75 | MKT> $260.36 | MKT> $92.34 | ||
Put Profit | $0.10 | $0.09 | $0.06 | ||
Put Loss | MKT <$284.55 | MKT <$249.60 | MKT <$83.69 |
Tuesday,9-20-22, morning. Ten minutes into trading today, we took our first profit. We closed the ADBE call spread at our profit target. We grossed $65 on the trade. Transaction fees were $2.60, leaving a net gain of $62.40. Our max risk on the trade was $170. Our net return on risk was 36% over one day. Our enthusiasm, however, is dampened by the performance of the ADBE put spread, which, would lose $34 if we closed it now. Never the less, the put spread is still above its short strike with the potential for its max gain. Although time is on our side in this trade as long as ADBE continues to trade above $285, we may consider closing it early as ADBE’s price continues to plummet today.
Tuesday, 9-20-22, after market close. The table below summarizes where we stand before accounting for transaction fees. So far, we’re ahead, despite the SP500 losing 1.13% of its value today.
Underlying | Share Price | Call Spread | Put Spread | |
ADBE | 291.06 | +65 (Closed) | -24 | |
MCD | 255.41 | -9 | +11 | |
MS | 87.21 | +8 | -6 |
Thursday, 9-22-22, morning. After yesterday’s announcement from the Fed the markets initially rose and then fell dramatically. The ADBE’s put spread hit our loss exit. Both of MCD’s spreads closed, the call spread at the profit target, the put spread at the loss exit. MS’s call spread closed at the profit target. Here’s our things look currently:
Underlying | Share Price | Call Spread | Put Spread | |
ADBE | 291.06 | +65 (Closed) | -102 (Closed) | |
MCD | 255.41 | +39 (Closed) | -55 (Closed) | |
MS | 87.21 | +27 (Closed) | -29 |
The performance of these trades is disappointing. ADBE and MCD gave us a combined net loss of $53. Transactions fees were $10.40. In total, we lost $63.40. The best we can say is that we avoided the max losses on these trades of $793. Could we have managed risk better? Many more experienced traders suggest avoiding trades when going into a major economic event. What do we make of MS with its later expiration date still being viable? Perhaps we’d have been better off trading a bit further into the future, choosing an option with more time left. These are considerations as we conduct further experiments in trading options.
All three of our experimental trades have now closed. Here’s how they turned out.
Underlying | Share Price | Call Spread | Put Spread | |
ADBE | 291.06 | +65 (Closed) | -102 (Closed) | |
MCD | 255.41 | +39 (Closed) | -55 (Closed) | |
MS | 87.21 | +27 (Closed) | -53 (Closed) |
Things didn’t go so well for us. It didn’t go well for many investors. The SP500 opened on Monday at 3849. Today it closed at 3693 for a loss of 4%. The max that we could have lost on our trades was 1128, if sides of each trade turned into losers. Realistically, that would be quite unusual. The far more likely scenario would be a max loss of half that amount, 664.Our realized loss was $210 (18.6% of the absolute max 37.2% of the realistic max) These numbers can better inform risk assessments in the future. What could we have done differently? We could have chosen a wider spread between our short strikes, as well as trading further out into the future. We could have foregone trading at all during a week with a Fed announcement. We could have shaved a few dollars off our loss by taking letting our bearish spreads expire and thus gaining 100% of the max profit on them.
Key take-away: Keep up with market impacting news and fully consider your exits and have them in place.
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