This is the perfect trade for busy schedules. I put this vertical
spread trade on in the first hour of trading on Wednesday,
7/9/2009. I was able to sell this spread for $.60.
Aug Put Vertical Spread 27/25
||1. Exit if I can lock in 80% of my
initial credit (i.e. $.12)
2. Exit if cost to close >= twice initial credit (i.e. $1.20)
3. Exit if XLU closes below 7/8 low of $26.72
The nice thing about this trade is that it has a $2 wide spread, which would be the maximum loss this trade could sustain, but I took in $.60, so my total risk in the trade is only $1.40.
While the rest of the market and many ETFs have broken the trend and are forming lower highs and lower lows, XLU remains in an up trend. I chose to put on a fairly tight put vertical spread with the understanding that any break of the trend or a cost to close of twice my initial credit I'll be out.
Choosing a the short strike was a little more difficult on this
trade. Ordinarily I like to chose a strike price a few strikes out of
the money. As I've discussed on the vertical spread strategy
page, I usually prefer a probability of expiring (worthless) of
30-40%. In this case, there is no $24 strike price so it's not
possible to go one strike price down.
This is a slightly riskier trade, however as we'll see soon, I
that a number of ways.
The worst case scenario on this trade is that I could potentially
lose $143/contract. However, one of my exit strategies is to
close the trade when it costs twice my initial credit to close. That
means my risk in the trade is actually only $60/contract. On a $20,000
account, I will risk just 2% on this
trade or $400. Therefore, I can take 400/60, or 6 contracts. The key to
using this approach is that I must be ruthless about exiting when I say
My exit plan is to exit when one of several things occur.
The key to following my exit plan is to have an order in place that
will ensure that one or the other of the first two strategies gets
executed. I can do this by entering a "one cancels other" order.
As I'm illustrating here, I can set up an order where one or the other gets filled and the remaining order is canceled. In order for this to work, I need a stop order to execute when the price reaches my max threshold. Note: in this illustration, I had $1.15 entered when the price should be $1.20. The other order is a plain old limit order to exit when I can buy back the spread for $.12.
The nice thing about this type of trade is that it is very low
maintenance so it can work well for folks who have busy schedules or
work during most of the trading day. In a trade like this, I put
the order in first thing in the morning and set up my exits as
well. Now, it's just a matter of waiting for one or the other of
my exits to trigger. At the end of the day, I can review the
trade and if I see the price fall below my technical level, I can
simply do a market order close first thing in the morning.
Since putting the trade on this trade, this ETF has pretty much gone up - after a few days of stalling and even slipping below the short strike of $27.
As I've highlighted here, XLU did establish a lower low although it appears to be remaining in a upward channel. The next question is whether a higher or at least equal high will be established. To do this will mean breaking the current resistance level at $28. However, with the number of strong up days, it wouldn't surprise me to see a pause or even small pull back before resuming.
This vertical spread has already made half the credit in time decay (i.e. I could close the trade for $.30).
A week later and we've really seen XLU contiue to move up.
Here the XLU is shown moving decisively above the $28.50 area I'd outlined last week. And with that, I think this trade is about ready to close. In fact, I checked today after the market closed and it appears that the mark (mid price) is below my bid price to close the spread. What's up with that?
The deal is that the bid/ask spread is fairly wide on this vertical spread and likely it will require me paying a few pennies above the mid price. This happens sometimes. While it's nice to get filled at the mid price, it doen't happen that often for me except on the SPY or DIA. Let's see what a few more days bring. There's still three more weeks until expiration and more time value that can decay.
Sure enough, this order filled first thing this morning. In fact I got filled at $.10 debit, a tribute to trading in a paper money account. This probably wouldn't have happened in a real account unless there was a considerable gap up. Since I just posted an update yesterday, I won't put up a final chart as the one above tells the story. This was an ideal trade. It went as planned and really required very little maintenance.
Here are the final status. I entered for $.60 credit but paid $.12 to close (I'm going with that because I likely would have filled at $.12, not $.10 in a real account). That leaves a net credit of $.48 on a total risk of $1.20. That makes my ROI 40% in just over two week's time.
And that concludes this trade... another successful one. For more information
on vertical spreads, be sure to check out the
overview page on this strategy.