This is fantastic. Opportunities like this don’t come along all the time to share with you. A trade that went bad but instead of loosing money, still managed to make a profit.
Strategy – Bear Call
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.
Reasoning
Expecting prices to pull back of an underlying stock for next few days and you are taking advantage of this. You are promising to deliver to a buyer a stock at a specific price and by a specified date as per the contract hoping that you don’t have keep that promise. You charge a small amount money known as premium for this promise. Think of your health insurance. You pay a small amount of premium every month to the insurance provider hoping to cover for all expenses in case you get sick. Whereas the Insurance provider hopes that you don’t get sick and they keep the premium as profit. The amount of premium totally depends upon the level of risk.
Idea of buying a further out call option is basically ‘you buying a promise from someone else’ to have the stock delivered in case you need it. Two main reasons to do this are – a) reduce your loss in case the trade doesn’t go as per your prediction b) reduce the capital requirement to do the trade. Capital requirement will be the difference between strike prices multi-plied by number of contracts.
Outlook and Action
REGN (Regeneron Pharmaceuticals Inc) was trading around $423 per share and I predicted prices would pull back for next few days and based on that I took a Bear Call Credit spread on Tuesday 09 May 17.
REGN traded outside the upper Bollinger band (purple lines in the chart) from Monday 01 May 17 till Friday 05 May 17. Friday 05 May prices showed bit of weakness and resisted Thursday 04 May 17 top. Between 04 and 05 May it formed ‘Bearish Harami’ candlestick pattern. Monday 08 May prices came back inside the Bollinger band and a “sell signal day” flashed with my technical indicator set ups. All it means is that prices are ready to have a short term pull back. Also most often it is very unusual for prices to trade outside the Bollinger band for that many days. On Tuesday 09 May prices opened around Monday’s close and started moving towards same direction as the signal day and that’s when I decided to take the trade. Though later during the day, prices started moving up. My short term prediction was that the prices will pull back and stay inside the upper Bollinger band for next 4-5 days. Strike prices chosen were outside the upper Bollinger band and above most recent high from Thursday 04 May, two lines of defence in favour of the trade.
| Side | Quantity | Symbol | Expiration date | Strike price | Type |
| SELL | 10 | REGN | 13-May-17 | 447.50 | CALL |
| BUY | 10 | REGN | 13-May-17 | 450.00 | CALL |
Capital requirement to do this trade was $2500 and have received $0.17 credit per share. If successful with the trade, I would make $148.05 net profit, that’s 5.92% return on the capital invested in 4 days. 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). |
| Projected Net profit | $148.05 | ($0.17 x 100 x 10 – $21.95 commission = $148.05 |
Managing the trade
It didn’t go as per my prediction. But instead, prices surged and hit the strike price I sold.
Wednesday 10 May, prices continued moving upwards. On Thursday 11 May price surge continued and broke through the recent resistance level (highest price level of $438.37 for Thursday 04 May) with a big volume. When prices crossed above $440.00 I decided to buy a ‘$435.00 strike CALL option (expiration August 17)’ to defend my spread trade. Eventually, I decided to close the spread trade, bought it back at $0.55 per share.
I lost $423.90 for the bear call spread trade. I had one call option which expires August 2017 open at this point. I anticipated prices to continue surge on Friday and as prices goes up, so goes up the value of the call option. Bought the call option for $33.50 on Thursday 04 May and sold it for $39.00 on Friday 05 May, which made me $534.60
Below are the calculations for all those transactions.
| Bear Call Spread | ||||||
| Side | Quantity | share/contract | Credit/Debit | Amount | Commission | Total |
| Sell | 10 | 100 | 0.17 (credit) | 170 | 21.95 | 148.05 |
| Buy | 10 | 100 | 0.55 (debit) | 550 | 21.95 | 571.95 |
| Loss | (423.90) | |||||
| Call Option to defend the trade | ||||||
| Side | Quantity | share/contract | Credit/Debit | Amount | Commission | Total |
| Buy | 1 | 100 | 33.50 (debit) | 3350 | 7.70 | 3357.70 |
| Sell | 1 | 100 | 39.00 (credit) | 3900 | 7.70 | 3892.30 |
| Profit | 534.60 | |||||
| Net Profit | 110.70 | |||||
I ended up making 4.43% of the original capital invested when I took the bear call spread, instead of loosing.
Other ways this trade could have been managed technically known as ‘legging out’, which basically means to buy back the sold call option($447.50 strike price) early and let the call option ($450.00 strike price) which was bought to run and sell it later on Friday with higher value.
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.