Take the trade and let the time go by, which it will. We can’t be certain of the direction of a stock price, so why depend on that? But one thing is certain is that the time will go by, Wednesday will come after Tuesday, Thursday after that and so on. Don’t you want to take advantage of this?
Strategy – Bull Put Spread
The strategy involves selling an Out of the Money Put Option of an underlying stock and buying further out (most often the next strike price) less expensive Out of the Money Put Option for protection. These selling and buying different strike price put 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 put option strike prices.
Underlying Stock – UNP (Union Pacific Corporation)
Reasoning
Expecting prices to go up of an underlying stock for next few days after being in oversold condition and you would like to take advantage of this. So you are going to sell some insurance (promise to deliver stock at specified strike price and date) hoping to never have to keep that promise as the insurance contract expires worthless.
You charge a small amount money know 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 put option is basically ‘you buying a promise from someone else’ to have the stock delivered to you in case you need to deliver it due to the other contract you sold. 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
UNP (Union Pacific Corporation) traded outside the bollinger band on 17 & 18 May and few of the technical indicators (RSI & Stochastic) showing oversold condition. General tendency of prices trading outside the bollinger band (purple lines) is that it comes back inside fairly quickly and stays inside for at least next few trading sessions. 19 May it came back inside the bollinger band and formed a bullish candlestick pattern (inverted Hammer). Hammer candlestick on 22 May indicates a short term price surge. A buy signal day flashed with few of the technical indicators I use on 23 May, which gave me the confidence to take the trade. Strike prices chosen were outside the bollinger band and below the lowest level from 18 May, from where prices bounced back up.
Chart from Thinkorswim platform
| Side | Quantity | Symbol | Expiration date | Strike price | Type |
| SELL | 10 | UNP | 27-May-17 | 105.00 | PUT |
| BUY | 10 | UNP | 27-May-17 | 102.00 | PUT |
Capital requirement to do this trade was $3000 and have received $0.12 credit per share. If successful with the trade, I would make $98.05 net profit, that’s 3.27% return on the capital invested in 4 days. Below is the calculation.
| Capital requirement/maximum loss | $3000.00 | 10 contracts, each options contract consist of 100 shares, $3.00 spread between strike prices (10 x 100 x $3.00 = $3000). |
| Projected Net profit | $98.05 | ($0.12 x 100 x 10 – $21.95 commission = $98.05 |
As expected, prices bounced back up and stayed inside the bollinger band and the contracts sold and bought expired worthless.
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.