http://finance.yahoo.com/news/why-costcos-shares-tumbled-april-144302464.html http://blogs.barrons.com/stockstowa...buying-opportunity/?mod=yahoobarrons&ru=yahoo http://www.msn.com/en-us/money/stockdetails/financials/fi-126.1.COST.NAS http://finance.yahoo.com/q/co?s=COST+Competitors http://finance.yahoo.com/echarts?s=COST+Interactive#{"range":"2y","allowChartStacking":true} http://stockcharts.com/h-sc/ui?s=cost Trade: With COST at 148.59 Oct 170/175 bear call spread for a net credit of $35 Yield = 35/465 = 7.5% in 165 days or 16.6% annualized Prob = 85% Expectation = .85(35) - .11(465) - .04(233) = 29.75 - 51.15 - 9.32 = - $31 Price.......... Profit / Loss...... ROM % 110.00............. 35.00............. 7.50% 125.00............. 35.00............. 7.50% 150.00............. 35.00............. 7.50% 170.00............. 35.00............. 7.50% 170.35............... 0.00............. 0.00% 175.00.......... (465.00).......... -92.50% 180.00.......... (465.00).......... -92.50% 195.00.......... (465.00).......... -92.50% 200.00.......... (465.00).......... -92.50%
October is awfully far out for a credit spread or really any spread using a single stock. They will have 2 more earnings reports between now and then and a good one can crush this trade if you are still in. Not to mention that far out time will not be helping you much. I am not saying you are wrong about direction or the timing, but that far out across two earnings reports is a pretty big gamble IMHO. Anything can happen in 5.5 months.
"anything can happen in 5.5 months" You see... that's the "hit and run" mentality of the typical option player. You fear the market because you have not taken the steps necessary to understand it. I just don't happen to use options in the hit-and-run model. What about people who deal with stocks in a much longer time frame... like in a buy and hold strategy...short or long? Would you also say such a strategy is ill advised because "anything can happen in 5.5 months"??? Lets say I had shorted COST because I had read all the references I cited, evaluated COST as a holding and decided that COST was a good short candidate because: 1. COST has a PE of 28 while its two major competitors have PE's of 15: http://finance.yahoo.com/q/co?s=COST+Competitors 2. COST has a SELL rating from Zack's, disappointed on its recent earnings report and runs paper thin margins: http://finance.yahoo.com/news/why-costcos-shares-tumbled-april-144302464.html http://blogs.barrons.com/stockstowa...buying-opportunity/?mod=yahoobarrons&ru=yahoo http://www.msn.com/en-us/money/stockdetails/financials/fi-126.1.COST.NAS Had I simply shorted at that point I would have had an entry point of 148.59. As it is I have an effective entry point of 170 for my short (a 14% advantage) AND, unlike a typical short position, I have a 5 point limit on any possible losses. Lets look at my position compared to a short: Price.......... Profit / Loss...... ROM %.........SHORT P/L 110.00............. 35.00............. 7.50%................3859 125.00............. 35.00............. 7.50%................2359 150.00............. 35.00............. 7.50%................(141) <-no change point 170.00............. 35.00............. 7.50%................(2141) 170.35............... 0.00............. 0.00%................(2176) 175.00.......... (465.00).......... -92.50%.............(2641) 180.00.......... (465.00).......... -92.50%.............(3141) 195.00.......... (465.00).......... -92.50%.............(4641) 200.00.......... (465.00).......... -92.50%.............(5141) So my position is a 'chicken short' My strategy over many trades has a positive expectation (this has been demonstrated in a study done by the CBOE which I have listed multiple times before but have not bothered to look up again today) while the hit and run strategy of the typical option player has a negative expectation and a longer term fail rate close to 90%. (same CBOE study). https://en.wikipedia.org/wiki/Expected_value
You pointed out a negative expectation on this trade: -$31 I assume some of your spreads show positive expectation when you initiate them. How does this calculation affect your opinion of a trade, if at all? It seems to me that the reward (in this case) is not high enough to justify the risk.
"You pointed out a negative expectation on this trade" My computation of expectation is very approximate and -$31 is probably not really significantly different from zero. If you wait for a computed positive expectation to make a trade you will not get many trades. This is probably correct. i.e. it's a rare event when the market allows a positive expectation to persist without taking it out. Thus you have to be very patient OR you have to jump the gun and make the perhaps silly assumption that the you are ahead of the market and they will catch up to you. In most cases I am trading on recent news while the computed expectation is using an approximate distribution assumption and a price history that is 'old'... and/or made old by the news. The recent news may or may not change the distribution enough to alter the computed expectation. (e.g. changing the std deviation of price) All of this adds up to: don't take the computed expectation too seriously. I like to see it but it's not that important. " It seems to me that the reward (in this case) is not high enough to justify the risk." I agree with that actually and I have yet to make this trade. If I do make it I am assuming I am smarter than the market...which may not be a smart thing to do. That's why I include these little clues in my posting. On the other hand... the market is a chaotic place with a lot of participants that couldn't compute an expectation if their lives depended on it and perhaps that noise level is enough to make the trade viable.
Filled @ $45 This makes expectation: Expectation = .85(45) - .11(455) - .04(228) = 38.25 - 50.05 - 9.12 = - $21
Well if it works for you congrats. I would be interested in reading the study you mentioned though. Always like reading things like that.
http://stockcharts.com/h-sc/ui?s=cost http://finance.yahoo.com/news/costco-cost-beats-q3-earnings-111511396.html http://www.cnbc.com/2016/05/26/this-is-whats-really-driving-costcos-stock-jim-cramer-says.html?__source=yahoo|finance|headline|headline|story&par=yahoo&doc=103668292 At this point COST is at $150 or so. Our short call point is at $170 so I am OK with leaving it alone. BUT I could add a bull put spread to create an Iron Condor under the theory that we have 'discovered' the bottom on COST: Oct 125/120 bull put spread for a net credit of $20 Net yield for the Condor would be 20+35 = 55/445 = 12.35% in 160 days or 28% annualized vs 17% annualized. The net change on my bear call spread so far is 3 cents. Am I going to bother? Prob not.
Exit Strategy Discussion COST at about $149.00 when trade opened. COST now at about $158.00. Short call strike at $170.00. The Oct 170/175 bear call spread for a net credit of $45 is now at about $90.00 To those that like to exit at 2x the credit received now is the time to exit - and lock in the loss. Some have posted that they exit when the short strike is reached - in this case the 170 call. IMO ....... Exiting a losing credit spread trade is impractical due to the volatility of options. A trade in the red can easily turn green the next day - so it's best to keep the trade open until expiration.