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There has never been anything I've done which hasn't taught me something. Often these 'lessons' are simply reminders of mostly insignificant 'truisms' of life. Occasionally they can call back into focus really useful principles we might have 'packed away' for a season. One of these was vividly placed before me in a trade last week. Visualizing The Trade - The Strategy The trade was a Key Level Stock Reversal on Aetna (AET). I came across the stock as I was reviewing the Key Level stocks in the Dedicated Trader's Trading Center. From the chart below, you can see that it was a prime candidate to move back up, having just halted a slide from a peak around $70, dropping like a stone to around $51 before starting back up. So.. let's trade it, but how ... Short term? Long Term? View Better Trades Chart 1 How To Trade? I decided to enter the trade when the stock had shown me enough rise to convince me that I had a bona-fide support level bounce. Checking some minor technicals, I reasoned that ... today is a good day to trade . Now the ONLY question was how to trade it! The stock is very expensive and I didn't want to tie up $55,000 of short term trading capital in a stock that MIGHT not perform in the next 5 days. I have bills to pay and they won't wait until I've freed up the capital to pay them. My short term trades are USUALLY stock trades rather than options. Admittedly, the stock will normally consume capital at a faster rate than options, but the profits can be MUCH faster as well, allowing me to get back to cash in a hurry if I need to. Since I wanted to trade this and had to make a decision rather promptly before the trading opportunity slipped away. My long term trades are generally designed to 'mature' in 30 to 90 days. I was having a hard time deciding which way to go with this when I thought ... why not trade BOTH ways ! To do that, buying the stock was out of the question ... way too much money would be tied up! That left only OPTIONS .. the calls, of course would be the way to go. Long Term Short Term Options Checking the options chain, I found that we had options available for August, September and October before the expiration months skipped out to January 2004. The short term play therefore would have to be the August expiration. The long term could go out to October; not as long as I'd like to have, but I reasoned that I'd be out of the trade in about 30 days anyway. Done! I bought the most heavily trade strike price (6600 contracts open interest); the August $60 call for around $.21 cents ... 30 contracts, tying up around $750 or so. All I'm looking for here is about a $200 profit to fulfill my short term objectives. That would require a rise of around $.06 cents per share in the option premium. A delta of .05 says the stock has to up a couple of dollars, realistically, to accomplish that. For the LONG term trade, I elected to go AT the money, buying 10 contracts of the the October $55 calls for around $3.30 per share. That consumed around $3300 for a trade that would probably last around 30 - 45 days. The trade is ongoing at this time, so I'll keep you all posted as to when they're concluded. In the mean time, let's get back to ... things remembered from above. When Premium Moves As most of you know, I love to trade the stock, trading options usually in the form of either covered calls or naked puts on blue chip stocks. Properly structured, this combination of strategies allows me to be at peace no matter WHICH way the market goes! The trade I entered on AET are both very DIRECTIONAL. That is, the stock MUST move UP for me to profit. I usually minimize my risk in any given trade with stop losses and/or trailing stops and this is certainly the case here. View BetterTrades Chart 2 The first day in the trade, I saw a LOT of movement in the stock price; very close to $1.50 on thisfirst day. This movement is about what I'd expected so I wasn't surprised when the stock move to a high of around .$56.20, though I have to admit the late market slide back to close at a lower $55.68 DID have my full attention! During this movement I saw the premium on the October $55 calls go as high as $3.90 at one point before slipping with the stock to finish the day around $3.40 Notice what the 'real life' delta was. The stock moved down from a high of $56.20 to the $55.68 close; about $.52 cents difference. The Oct $55 call premium moved from $3.90 down to $3.40, about $.50 cents. That's very nearly a PERFECT delta! The OTHER position was a different story! Recall that I had purchased 30 contracts of the August $60 calls for around $.21 per share. During the day, the stock moved from a low of $54.76 to a high of $56.20, showing enormous volatility for such a 'heavy weight' stock. The longer term, AT the money, Oct $55 calls showed premium movement between $3.30 (where I bought them) to a high of $3.90! While all this was going on, the Aug $60 calls never moved over $.10 cents, closing around $.20 cents on the bid! The ... thing remembered here for me is that the movement on very short lived (August expiration qualifies here) OUT of the money calls, can be and often IS almost NON-existent! View Better Trades Chart 3 So what's the lesson in all of this? Well, I suppose until either or BOTH of these positions is closed, the lesson specifics will have to be postponed. That said, I would like you would be or 'wanna be' options traders to remember a couple of important aspects of options trading. Trading Options Vs. Stock Keep a couple of things in mind in making that decision. First, the amount of profit you bring in is exactly equal to the difference between the price at which you BUY the position and the price at which you SELL the position, no more, no less! Maximizing our profits requires that we maximize the MOVEMENT in the 'cost' or value of that position. From the chart at the left, you see that the stock had moved from the low around $54.76 to a high of $56.20. buying at or near the low and selling at or near the high (using a trailing stop) would have brought in around $1440 (with 1000 shares - $54,760 tied up). In other words, you collected as close to 100% of the movement as is humanly possible! Trading the October $55 call (10 contracts with $3300 tied up) would have brought in around $600. Arguably a much stronger position ... this time. However, don't forget the meager $.10 cent move on the shorter term Aug $60 calls. The profit in the options trade then is largely a matter of choosing the RIGHT option. Unless you're proficient in your option selection process, you can find yourself missing the train almost entirely here. So what did I 'remember' here? Knowing HOW to select option strike prices here is KEY to successful option trading. Additionally, SHORT TERM options are extremely risky and you'd be well advised to restrict your activities there to ONLY purely RISK capital! I'll keep you all posted as to how this trade progresses. Just keep checking the Trade Record. As I see it now, I expect the stock to continue to wiggle it's way up over the next few days. My short term Aug $60 calls expire on Friday, so that trade is somewhat in doubt. The longer term Oct $55 calls at this juncture appear to be on much more sold ground! Make it a great day!! Bob
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