The River Runs Dry
The equities market looks bleak for the the time being and maybe for the next few weeks as well. So if stocks won't go up then you go down with them and by that I mean, adjust trading strategy. What's the play? Something called the bear call spread.
We have often written on the bull call spread which is a short term trading strategy to use when you believe a stock is going up. We have had much success employing the bull call spread but it is only effective if the stock goes up. So when the stock is going down you do the inverse, you play the bear call spread. So how does it work?
You sell an out of the money call and simultaneously buy a further out of the money call of the same expiration. So if Alaska Air Group (AKL) stock price is trading at $65 and you think it's headed down further or not moving much above the current price at all over the next month, you can sell a $67/$70 call spread. This translates into a options trade comprised of two legs where one leg is selling (shorting) the $67 call and the other leg is buying the $70 call. The lower AKL goes the more profitable your position; you collect whats called premium and longer the stock is depressed the better for you. If the stock goes up to $67 and above your position is at a loss and the higher it goes the bigger the loss, yet your max is defined when to enter the trade.
In this very stock I would sell the 20 April 67/70 call spread. If I'm right then my max profit for one contract is $42 and if I'm wrong my max loss is $208. You might be asking yourself why would anyone risk $208 just to make $42? The answer is because my probability of being right is high in this strategy, thus the pay out is low. Think about how outcomes with great odds have great pay outs such as lotteries. Well the inverse of that is lower odds equates to lower pay outs which means better chances of winning. I rather take a surer $42 than wasting one dollar, 208 different times at an attempt to win $4,200. Most situations in life don't reward that well or we would all be well off, wouldn't we?
Execute the trade in the paragraph above in your paper account to get a feel for it. And if you have questions call me on my cell 919.740.5610, I would be glad to talk to you.
