When markets are as turbulent as they are now, unless you’re a stock like AAPL which many have been bidding higher because they view it as a “safe haven” asset, it’s a bit difficult to overcome overbought conditions.
What generally needs to happen in volatile market environments is that a stock needs to have all of its ducks in a row to power higher.
Those ducks can often look very different, but they will typically include things like favorable news, sector leadership, expandable momentum, and little in the way of resistance.
Today, I am going to show you a stock that has NONE of these going for it, which is why I chose to play it from the short side by using a special options spread trade.
Option trading is so much more than just straight puts and calls
Now, I know that buying straight puts and calls can be exciting since the profit potential can be spectacular when you place the perfect trade.
However, it’s important to dabble in using other strategies, such as options spreads, to help improve your odds of success in some situations.
As part of my Total Alpha service, I usually keep it simple when it comes to spreads, and the spreads that I utilize are statistically proven to give some of the best probabilities of success of an options trade.
In one of my latest trade ideas, I purchased a “put spread” in Digital World Acquisition Corp. (DWAC).
According to Yahoo Finance, Digital World Acquisition Corp. does not have significant operations. It intends to effect a merger, capital stock exchange, asset acquisition, stock purchase, reorganization, or similar business combination with one or more businesses in the technology, SaaS, fintech, or financial services sector in the Americas. The company was incorporated in 2020 and is based in Miami, Florida.
Having a forecast is critical to choosing the right options trade
I chose to play DWAC from the bearish side, primarily because the stock recently rallied hard up to a wall of resistance, at a time when its sector (Financials) has been struggling.
These details can be seen in Figures 1 and 2 below.
Understand that if I were to simply buy puts to express my bearish view of the stock, I’d be betting that the stock must fall aggressively and in relatively short order to be profitable.
While such a development was a possibility at the time I placed the trade, it was not the highest probability outcome.
Enter “vertical spreads.”
Vertical spreads offer a higher probability of success because the underlying stock does not need to move as aggressively as when you purchase straight puts or calls.
Your outlook before you place these trades should be “moderately bearish,” as opposed to “aggressively bearish” if you were buying puts.
In addition, these spread trades are the easiest multi-leg options trades to learn, since they only require that you either buy and sell calls or puts WITH THE SAME EXPIRATION DATE.
Again, the appropriate time to use a “bear put spread” is if you are only moderately bearish on a stock.
Like any vertical spread, you can either take a profit or close the trade to protect against large losses (i.e., get stopped out of the trade) at any time prior to expiration.
But in order to earn the maximum profit, the trade must be held through to expiration.
Here are the mechanics of the trade:
BTO 50 Dec 17 65 Put @ $8.33
STO 50 Dec 17 50 Put @ $1.83
Potential profit is limited to the difference between the strike prices minus the net cost of the spread including commissions.
For this trade, the difference between the strike prices is 15.00 (65 – 50 = 15), and the net cost of the spread is 6.50 (8.33 – 1.83 = 6.50).
The maximum profit is realized if the stock price is at or below the strike price of the short put (lower strike) at expiration.
The maximum risk is equal to the cost of the spread including commissions. A loss of this amount is realized if the position is held to expiration and both puts expire worthlessly. Both puts will expire worthless if the stock price at expiration is above the strike price of the long put (higher strike).
The breakeven stock price at expiration is equal to the strike price of long put (higher strike) minus the net premium paid.
With DWAC now falling closer to the Dec 17 50 Put that I sold in the time that has passed since I first placed the trade, price is certainly heading in the right direction.
To YOUR Success!