Underlying Stock – BABA (Alibaba)
Strategy – Bear Call (Credit) Spread
The strategy involves selling an Out of the Money Call Option of an underlying stock and buying further out (most often the next strike price) less expensive Out of the Money Call Option for protection. These selling and buying different strike price call options creates a credit and that’s the maximum profit for the trade if successful. Maximum loss will be the difference between sold and bought call option strike prices.
Outlook and Action
Prices traded outside the Bollinger band from 17 August till 24 August, general tendency is that once prices trades outside the Bollinger band, it comes back inside and stays inside for a period of time. Friday 25 August, prices came back inside the Bollinger band and closed below the opening price. A sell signal flashed with some of the technical indicators I use in my trading system. RSI were indicating overbought state and RSI and MACD histogram both pointing down. On Monday 28 August, as the pullback followed through, I decided to take the trade. Also between 23, 24 and 25 August formed a bearish candlestick pattern (evening star), which added extra confidence to take the trade. Only red flag for this trade was that BABA is on a very strong uptrend. When prices gapped up on Wednesday 30 August, I kept a close eye on the trade and was mentally prepared to manage the trade. But didn’t had to as that upward move didn’t follow through the next day.
| Side | Quantity | Symbol | Expiration date | Strike price | Type | Price | Net Price |
| SELL | 10 | BABA | 02-Sep-17 | 177.50 | CALL | 0.27 | $0.12 credit |
| BUY | 10 | BABA | 02-Sep-17 | 180.00 | CALL | 0.15 |
Capital required to do this trade was $2500 and have received $0.12 credit per share. Means got paid upfront $98.05 after paying commission for the trade and that’s the profit which turns out to be 3.9% return on the capital invested in 5 days. As long as prices don’t hit the sold strike price by the expiration date (Friday 01 September closing price), these contracts will be worthless and I get to keep the money I received. Below is the calculation.
| Capital requirement/maximum loss | $2500.00 | 10 contracts, each options contract consist of 100 shares, $2.50 spread between strike prices (10 x 100 x $2.50 = $2500). |
| Net profit | $98.05 | ($0.12 x 100 x 10 – $21.95 commission = $98.05 |
P.S Please note that the trade is now closed. Do not copy and place a trade unless you are an expert and know what you are doing. This writing is only for educational purposes. Trading is risky without proper knowledge, practice, expertise and mentorship.