Case Study of the Week
This case study is based on actual trades using the strategies taught by the team at Options Money Maker. Our focus is to teach traders a consistent and conservative approach to trading credit spreads, debit spreads and other combination spread strategies to earn higher than average returns.
We believe that there is no better manager of your money than you, armed with the education and experience to create great returns and do it with peace of mind. We also believe that there is no better way to learn than to “mimic the masters” and then actually do it yourself! These case studies are designed to be a supplement to your education and show you real examples of the trades we open, close and adjust while minimizing risk, eliminating fear and growing a big account.
A number of our previous case studies have focused on the use of credit spreads; either Put or Call spreads depending on the anticipated bias of the market. This is a great strategy that brings cash into your account and provides a defined maximum gain as well as risk. This case describes the use of a debit spread which the investor buys as opposed to selling the credit spread. Debit spreads use different expiration dates for the long and short legs and requires expending cash from your account. A Put Debit Spread was opened on SPX at a time when the directional bias was down. We opened a long put with 4 weeks to expiration at 1190 and opened a short put with 2 weeks to expiration at 1160. The net debit was $19.50 which represented a cash expenditure.
Over the next week the SPX drifted downward and we began to see a profit on the Put debit spread. Now that the market was moving in the anticipated direction, the next question was, when do we decide to close the position for a profit? We used the Good-til-Closed process (GTC) to establish an automated order. A 20% profit on $19.50 is roughly $4.00. We therefore placed our order to sell to close the position at $23.50.
What Happened Next…?
As SPX continued to decline, we observed that we could sell to close the position one morning at $22.50 which represented a $3.00 profit on the position or a 15% gain in less than a week. Since there were some technical indicators showing a point of support for SPX, there was a high likelihood that the index would begin to retrace to a higher level. If this were to occur, this would wipe out our current profit and make the position more difficult to manage. Many of our investors chose to cancel the GTC order and close the position for a great 15% gain.
Greed is the Downfall of Many Investors…
Some of our investors decided to hold the position because there was still plenty of time prior to the expiration periods for SPX to cycle up and back down creating an even greater profit.
There was no one right answer in this case. The decision each trader makes is based on their personal views and attitude towards risk. This case study points out the need to learn how to think like a trader versus just following a set of rules. Want to make a profit on a high percentage of trades and manage unfavorable trades from a loss to break-even or an eventual profit? We sure do! How about you?