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Saturday, December 3, 2011

Bear Call Woes (Wall Street)

I had just decided, in this crazy stock market of ours, that Bear Call Credit Spreads were my strategy of choice. I loved them for a few reasons.

1. You get your money up front, rather than when the trade is over. (Of course it
isn't really your money until the trade is over and you've won. But the cash in your hand...a bird in the hand, so to speak, is psychologically pleasing.

2. Because you're trading a bearish (downward) trend, it is EASY to find good candidates in this market of ours which has been more often falling.

3. Time is your ally in this trade. In stock options, time decay is usually the enemy, each day subtracting pennies from the value of your option. But with credit
spreads, because you are shorting (selling) an option, the time decay is on your side,
since the short call is your primary leg of the two-leg trade.

I found First Solar (FSLR) which has been in a death fall since last July, and began making bear call credit spreads on a weekly basis. (it has weekly options; not all stocks do). It looked like a cash cow, week after week. And I was feeling ever so confident.

THEN, last week, the market rallied and the FSLR stock price soared up, right through my short call strike price of $48. This is exactly what you do NOT want to happen in a bear call credit spread.

So, this was an expensive learning lesson, all around. First of all, if you don't buy back your short call when it goes in the money, you will/could get assigned, and if that happens, you will lose your maximum loss. So, it is important to buy back the option, but that still incurs losses.

Credit Spreads are the most difficult of the spreads to make adjustments on, and since these are weekly options with little or no time left, it's impossible--one thing I learned.

In addition, there is a timing issue with your brokerage. If your short call goes in the money, your broker will start warning you about it, and IF you do not buy it back, putting it out of jeopardy, the brokerage will do it for you! Without your permission! So, it doesn't get assigned. (Assignment means buying the actual shares of stock, usually thousands and thousands of dollars. If your fund is not flush, you can't pay for this stock, so the brokerage prevents you from getting assigned in the first place.)

But here's the real quandry: Let's say my short call is $48 and the stock goes up to
$47.50 on the day of expiration. One would think you might squeak through, and WIN the trade if the stock doesn't go up to $48. BUT, there is one hour of after-hours trading after the market closes, and if that stock moves between 4 pm and 5 pm, you have NO control over your option. You can no longer buy it back, and your broker will do for the maximum loss.

I called around to different brokers to find out the RULES for this assignment business, and surprisingly got different (and some incorrect) answers, depending on who I asked. But my mentor assured me that if I go to CBOE, I will find their rules and the 4pm to 5 pm trading window is the one that is enforced. So, what I learned is to make sure I get out of that trade before expiration, and asap if the trade turns against me.

I lost a lot on this last trade. The bear call woes. But I have this strategy etched on my heart now. I'll never forget how it works. (I can't say that for all the other spread strategies I'm studying).


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