Is This The End? And...Trade Results - PYPL

Is This The End? Hello Smart Option Sellers! Yesterday ended in brutal fashion, with final support levels giving way for all the major stock indexes. The markets were cruising along on their highs yesterday until the Fed announced the rate hike at 2pm EST. It wasn't so much that the Fed raised rates, which was widely expected, but I believe it was the not-dovish-enough rhetoric that came across from chairman Powell during the conference call. The markets interpreted the comments as not friendly for the future and unleashed the sell orders. So where does that leave us? I believe there's more selling to come, even though things are getting a bit oversold. We could see a short-term snap-back rally, but at this point, I think any rallies will be sold into. For now, we are going to hold off on any new put-sell positions, only because the conditions won't be ideal. We need to see signs that a strong bottom is forming, and that buyers are ready to take the market back up. Our time now will be spent defending the positions we have, which might include a few more roll trades. Other than Big Lots (BIG) and now Alcoa (AA) by a smidge, all of our put-sells still remain below the stock price. That is somewhat comforting knowing that our strategy has given us deep cushion for moves like this. Yes, our positions are underwater, but clearly at much more digestible levels than anyone who has bought stocks outright over the last few weeks. Remember, until, and unless, the stock moves below the strike price, we will not be forced to buy any shares of stock. Consider what would happen to our positions if they all expired today - they would expire worthless and give us locked in profits (with the exception of BIG & AA). The only reason why our positions have value today (above what we sold them for), is because there's still time left until expiration day. Time = opportunity for the stock to keep dropping, hence, each put option still retains some kind of value. Our only concern at this point is do we want to try to lower our potential buy-in price on our holdings? Do we roll, or sit tight and let the market do its thing? Is $55 a good potential buy-in level for Kellogg (K)? Is $15 a good potential buy-in level for Advanced Micro Devices (AMD)? Is $62.50 a good potential buy-in level for Nike (NKE)? You get my drift? They've all undergone healthy pull-backs at this point, so who's to say that buying now would be bad? Considering that we could build a great long-term portfolio with these stocks, does it matter so much whether we might be slightly underwater for a period of time? Stocks have been the best-returning asset class over the last 100 years. You have to be in it to win it. So how do you know when to step up and buy? No one rings a bell to let you know the bottom is in. You just have to close your eyes, buy the stock, and know you've done your due diligence. But... That doesn't mean we can't try to reduce our buy-in level via "rolling". I have no problem with that, as it would give us an even better potential entry. But at some point, we need to let the long-term investing mindset take over and buy the shares. Anyway, I'll continue to monitor the trades, and if we need to roll, we will. Trade Results - Paypal (PYPL) Let's go over yesterday's successful buy-back trade on PYPL. For the few hours before the Fed announcement yesterday, we had ample time to close this position out at good prices. Most of the fills went across the tape at $.07 & $.08 per contract, so we'll take the official mark at $.08 per. Even if you had your order in to buy at $.10 per contract as specified in the original instructions, you would have been filled by the end of the day. Here's what we did: Bought back (bought-to-close) all of the PYPL February 15, 2019 $45 put options for an official buy price of $.08 per contract as a closing transaction (bought-to-close). Here are the profit details: We originally established (sold-to-open) this put option on November 20, 2018 for a sale price of $.26 per contract, and now we took gains by buying it back (bought-to-close) for $.08 per contract. With the fill at $.08, it locked in a gain of $.18 per contract ($18 for every contract traded) and a return on margin (ROM) of roughly 2% in a just one month's time. If you like to annualize, that's roughly a 24% return. You might notice, that although our dollar gains are typically the same for each trade, our ROM can fluctuate quite a bit. The reason being - the strike price has everything to do with how much margin you will be required to hold aside, and thus, will affect your ROM. The higher the strike price, the higher the margin requirement. And vice versa. This is the main reason why I like to focus on lower-priced stocks - typically $50 and under. To understand how the margin works and the calculations involved, here's the breakdown: Whenever we sell an option contract, your broker will require you to maintain a "margin requirement". The margin requirement is made up of funds that are already in your account and will need to be held aside while the trade is active. You are not borrowing money from anyone nor are you paying interest to anyone. Some people can confuse the margin requirement with "trading on margin". They are completely different concepts. We are not "trading on margin" when selling put options (you can read my Margin Primer in the Members-Only section of the website). The margin requirement is typically 20% of what it would cost to buy 100 shares of the stock at the strike price. In this case: 20% x $4,500 = $900. Your specific margin requirement at your broker may be higher or lower than that. If you are unsure, just ask them. Your margin requirement will also have an effect on your final ROM. So for this trade, our margin requirement is $900 per each put option contract sold. Our profit on this trade turned out to be $18 per each put option contract sold. Hence, the return on margin (ROM) comes out to $18/$900 = 2%. Also, the fill at $.08 allowed us to capture 69% of the full profit potential ($.18 gain/$.26 full potential = 69%). When selling options (puts or calls), your full profit potential is capped at what you initially sell the option for. In this case, that amount was $.26 per contract. We like to close trades early (buy-to-close) before expiration when we can capture at least 80% of the full profit potential. This is called my "80% Rule". Locking in early wins is just smart money management and it allows us to free up cash to put towards new trades. In this case, we settled for less than 80%, but the current environment called for making that decision. Congratulations to those of you who participated. If you still hold the position but didn't have a chance to place the buy-back trade yet, you should follow the instructions from yesterday's alert. Nike (NKE) Just a quick follow-up note on yesterday's unofficial hedge trade on Nike. NKE reports earnings after the close today. If anything comes across as even remotely negative, the stock could get hit harder than usual, due to the current market environment. The unofficial hedge trade can be used to stem any large losses on our current NKE put-sell position if a big drop occurs in the stock. I gave an unofficial recommendation to buy the December 21 or December 28 $60 to $62 put options for not more than $.15 per contract. At the time of yesterday's alert, those trades were attainable for anyone who wanted in. If NKE craps out and drops below the strike price that you bought, your losses would be capped to the small width of the spread. For instance, if NKE finishes at $59 on Friday, the December $60 put would be worth at least $1.00 per contract and the January $62.50 put would be worth at least $3.50 per contract, leaving a $2.50 difference between the two. As mentioned, the loss could never be more than the distance between the strike prices ($62.50 - $60 = $2.50). That is a quick and easy way to determine the maximum risk in any option spread. Using spreads can give peace of mind in trying times knowing that your risk is capped and limited. This is the main reason for which I'll be launching Vertical Spread Trader after the new year. I'll give a final NKE update on Friday, especially if we need to make a roll trade after the earnings. That's all for now. Look for another possible alert later if adjustments are needed. Continue to hold all other open positions as-is. Regards,