Something From Nothing - - An Options Trade

There are many components in Options trading that one needs to consider such as the strike price, days to expiration, delta (and/or other Greeks), underlying stock and so forth. But that's not all. Volatility as a lot to do with options pricing.

Right now, as I right this HUB volatility is very low, which means that it is a great time to buy options, especially if you can get them for free. In this HUB I will show you a great trading strategy for times when the volatility is low, which can be monitored by the VIX (Volatility Index). Here is a recent trade that I put on.

I am going to give you the parameters for a trade I recently made. I am not going to give the symbol as I don't want this to be misconstrued as a position one should take.

As stated above volatility has been very low therefore I am looking to buy an option. In this particular setup, I had been watching a stock that I felt was VERY overvalued. I really expect this to come crashing down at some point as it really isn't a good company and it's price is extremely high.

We had a very strong down and everything and it's brother seemed to be up, except this stock that I had been watching. It was also trading very close to it's all time high. When I saw that it couldn't break through on such a strong day I knew it was poised to drop. However, nothing is guaranteed.

Stocks can do only three things. They go up, they go down, or they are flat and trade in a sideways range. This particular stock looked like it would either be flat or go down and the likelihood of it going up was minimal.

When I constructed the trade this particular stock was trading in the $170 area. I first constructed what is called a Bear Call Spread. In other words, I was able to sell a $180 Call and simultaneously buy $185 Call. This was a way from this companies all time high and I felt that it would really struggle getting over this amount.

However, this is where my risk is. If the stock price rises above $180 I would start losing money on this position, but limiting my risk in theory to $500 (I'm not going into the actual calculations). For taking on this risk I received a premium because the 180 Call I sold had a higher value then the 185 Call I bought, thus giving me a net credit.

Because I felt that this stock would drop in price I wanted to profit from the fall therefore I bought an out of the money Put (same expiration month). I usually buy in the money or at the money options, but in this case I am wanting to profit from either an increase in volatility or the actual movement of the stock. Therefore, I found an option whose price could be paid for from the premium I collected from the Bear Call Spread I created. I was able to do this with a $155 Put.

In the construction of this spread, after commissions, I had a net credit of $15.00. As long as the price did not exceed $180 I would either profit greatly or net $15 at expiration. The only way to loose money is for the stock to rise above the $180.

Next I will tell you what happened.

First off, before I tell you what happened, remember that this trade paid me a small amount to put it on while also covering all my commissions.

I was right on the weakness of this stock. Within just a few days (less than 10) I had over a 50% return on the long Put that I owned. Because of the nature of how this stock trades I felt that it would try to bounce again and so I took my profits on the long Put leaving me with only the Bear Call Spread (I still didn't think it would increase past $180).

I ended up getting out of my long Put two days early, but I was happy with my returns. Then I just sat on my spread which netted me another 30% upon expiration.

The good news is that there are a bunch of deals out there at the time of this writing where being net long has a lot of potential. I presently, at this writing, have three such positions as I have described and as of now all three look like they will end up being profitable.

Happy Trading!