The Next Four Weeks

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Tough times lie ahead. Four long weeks, to be exact. In my recent analysis titled Looking Ahead, I made a strong case for an imminent 5 percent pullback from current levels. In reaction, I decided to put some money at work, as shown below. 

Basically, I sold the November 18 2016 216/217 credit call spread and, as a result, collected 50 cents/share, or $50/contract since one contract represents 100 shares of the underlying (trade #1736). In fact, I sold 200 of those babies and collected $10K in credit. Clearly, this nice sum of cash is mine to keep as long as $SPY remains below $216 by expiration (i.e., November 18th). Needless to say, any trade could go awry, and so I'll be watching the market like a hawk in the coming days and weeks. Should the need arise, I stand ready to make any required adjustments to the trade.

In trade #1737, I decided to press my luck by using almost ~75% of the proceeds from trade #1737 to place a directional bet. In other words, out of every $50 I collected, I spent $37 on 1 x 214/213 bear put spread with the same expiration.  

The payoff diagram below illustrates what I stand to achieve by November 18th. 

  1. Should the $SPY close at or below $213 by expiration, the $10K I collected from trade #1736 would be entirely mine to keep. As for trade #1737, the put spread would expire in the money, making me ($100 - $37)/contract. All in all, excluding slippage, my profit would be (200 x $50) + [200 x ($100 - $37)] = $22,600K.  
  2. Should the $SPY close between $214 and $216 at expiration, the $10K I collected from trade #1736 would still be entirely mine to keep, but the put spread would expire worthless. Hence, my profit would only be  (200 x $50) - (200 x  $37) = $2,600K.
  3. The worst case scenario would occur if I kept my arms crossed as I watched the $SPY close above $217 by expiration. This, of course, ain't going to happen unless I get run over by a truck. So, between now and November 18th, I plan on keeping my driving time to a minimum, and I'll also make sure to look left and right before crossing the street. 

The capital at risk is $17,400, or 5.8%, given my $300K account. (Note: I keep my account fixed at $300K on a monthly basis). But let me again reiterate that I would only incur such a loss if I didn't actively manage the trade in accordance with the price action, which is a fact of life in the market. That's how losses are minimized and losing trades are turned into winning ones. 

If any of the aforementioned math confuses you, let me know.

Trade Smart,

Peter Ghostine (@peterghostine)

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