Case Study: VLO Put Credit Spread Trade

As promised in my First post, I propose to demonstrate by means of case studies the various principles I have outlined on this website. Hopefully these options trading case studies will help beginning investors and traders realize that investing and trading is not difficult (as folks may fear), and can be done easily by being disciplined and following a series of logical steps. Please refer to the other articles on the site for more details about the principles and strategies I employ.

As noted in my essay on Winning Trading Strategies, the essence of successful stock options trading can be reduced to a simple 1, 2, 3 strategy!

1. Create and Monitor a Stock Watchlist
2. Wait for a High-Probability Trade setup
3. Initiate a High-Probability Trade with an Automatic Exit plan

Step 1: As noted in Create and Monitor a Stock Watchlist, I have and routinely monitor a list of Liquid Stocks using a VectorVest Watchlist. Having a watchlist of a small number of stocks (rather than attempting to search the entire universe of stocks) makes it easy to watch for trading opportunities. Everyone should have and monitor their own watchlist.

VLO Chart 1: VLO breaks above resistance

Step 2: On reviewing the graphs of the top 10 stocks on my Liquid Stocks List on Jan 4^th 2013, I noted VLO had broken above prior resistance on Jan 1^st (see VLO chart 1). Anticipating a further move higher, I decided to initiate a high-probability trade on VLO. Of the many choices available (a discussion for another day), I chose to initiate a Bull Put Spread (Put Credit Spread) by selling the 2013 Feb 32 put and buying the 2013 Feb 30 put (see Excel table for details of trade).

VLO Put Credit Spread

Explanation for choosing the Put Credit Spread as a High-Probability Trade:

1. Since stocks can only rise, stay where there are or drop, should VLO fail to breakout to the upside, the trade will be profitable even if it merely stays where it was and above the 32 short strike (greater than 66% chance of being right)
2. Downside protection to the short strike was 8.5% (although breakeven would be lower than the short strike by the premium received)

Trade Plan: Prior to placing a trade, it is important to write down a trade plan that summarizes why one is entering the trade, the proposed details of the trade, and the plan for how to exit (close) the trade. The plan does not have to be elaborate, but it must be done prior to entering into the trade. Sometimes, while thinking about the plan, I may decide that a trade is not worth entering after all.  Here are my entries with regard to the VLO trade.

1. Entry Rationale: Strong up move on VV today, support above 32.89
2. Position Size ($):20 contracts – 2pt spread
3. Technical Stop: Break below 32 – roll out
4. Profit Target ($): at least 80% of max profit – to close with 1c GTC order
5. Market and Sector Stops: tighten stops, roll out if market or sector break down

Step 3: I initiated the trade following the steps described in How to Trade Stock Options Online.

1. I used a limit order to enter the trade, thus ensuring I knew how much credit I would receive
2. Once the trade was placed, I placed a GTC limit order to close the trade – since, I am unable to monitor the market constantly
3. The GTC closing order was placed within minutes of the initial trade being placed (see green box on VLO GTC order picture)

VLO Chart 2: VLO continues its upward journey

Review: So, how did I do? VLO continued its upward move (see VLO chart 2), and my trade was closed automatically by the system when my GTC closing order was triggered (see red box on VLO GTC order picture). The trade was profitable with a 10.28% return on risk in 25 days, which would equate to a 150% annualized rate of return (although, this would not be a fair statement, as I would not be in the market for all 365 days with the same trade) (see Table). By having a resting GTC order in the system, I find that I am invariably out of the trade faster (because of intraday moves) than if I were attempting to decide when to close on a daily basis. This allows me to deploy my money faster for more trades.

VLO Trade nets 10.28% ROR in 25 days

VLO GTC order

I hope the above discussion has been useful to some – especially beginning options traders. I’ve added a picture of the broker’s confirmation as a way to authenticate that these are real-world strategies that work, and not theoretical fantasies.  I welcome comments on my system, and look forward to learning from other’s experiences.

Happy Trading!