But, I like to keep the advantages stacked on my side and sometimes you have to change the plan a little bit to keep the advantage vs. the market.
Look at the chart to see what happened to PENN today:
Let's first review our trade up to now. The stock was in a downtrend, and we entered on our trigger, which was a close below the low of the high day - represented by the blue square.
The next day after we entered, the trade went against us. Then the following day (today), it went against us again!! Curse you market - how dare you not play by our rules! Anyway, I'm not too concerned about that besides it didn't hit either of our stops and it's still under that downtrending resistance line (in blue).
Up until now, we would just have to deal with it and hope that it turns back down and goes to hit our target, or it would hit our stop and we would take a loss. But we now have a new trick up our sleeve - it's called "selling an option".
What does it mean to sell an option? Easy, just as it sounds, you pick an option and sell it to the market. The weird and wonderful thing about the market is that you don't have to own something in order to sell it (this is called a "short"). Where else in the real world can you do this - legally?
Here's how selling the option works, you simply do the same as you did when you bought an option - but rather you pick to sell it instead. Voila', easy enough.
Why do this?
Because you will bring in a premium (i.e. money). This premium will help to offset your loss if the stock continues to go against you and hit one of your stops. Also, remember that options have "Theta" (i.e. time decay) and if you BUY an option then time decay is working AGAINST YOU. But when you SELL an option, then time decay works FOR YOU.
Let's think a bit more about an option in general. You know the option can be bought or sold to the market at any time. You also know that the option will vary in price due to the stock's movement and also time (the more time that's in the option the more expensive it is). You also know that due to "Theta" that the option will decay in the time portion of the option price as we get closer to the expiration date of the option.
Keeping the above in mind, let's think of an example to clarify things:
Let's say there's a market for ice cream cones - this market will buy and sell ice cream cones at any time. So, you go up and buy an ice cream cone and then hang onto that thing for a couple of weeks - you live in Florida and it's hot out there and you don't keep that ice cream cone in the freezer. So, after a couple of weeks, that ice cream cone is a mess - there's basically no ice cream left. So, you sell it back to the market. But the market says, yes we'll buy it but for way way less than what we sold it to you for because it's a ton less valuable now than what it was then. So in that case you were the buyer.
Instead of buying that ice cream cone, you are now going to sell it to the market (yes, you don't have one to begin with, but the market doesn't care and they basically cover you for it). The market says okay, the ice cream cone is worth $5 (it's expensive ice cream) so they essentially front you the $5 via what's called "margin" (like a line of credit) and they buy that ice cream cone from you. Again, it's hot and it's Florida and they don't use a freezer and a couple of weeks later that nasty ice cream cone is now worth $1 and you say okay I'll buy that ice cream cone back from you now to cover my "margin" (line of credit). So, you originally sold an ice cream cone that you didn't have, essentially you were -1 ice cream cones, then you later bought the ice cream cone +1, then you came out with 0. You don't end up with an ice cream cone, you are now even steven. However, since you sold it for $5 and bought it for $1, you made a profit of $4 on the transaction.
Now let's figure out what may happen if we sell an option at this point referencing the chart way above. We'll get into the specifics about selling an option after the scenarios immediately below.
We have a few things that may happen from here:
1. The stock keeps going against us (up in this case) and hits our stop.
We lose money on the initial option we bought, BUT the option that we sold also becomes less valuable (therefore we win money on that one). We will still have a NET loss, but it will be quite a bit less vs. if we didn't sell an option.
2. The stock just trades sideways and doesn't go anywhere for awhile.
We are losing Theta on our option that we bought, BUT the Theta on the option that we sold is really killing the value on that sold option MUCH quicker than the option we bought. So we are NET winning money - or possibly breaking close to even. In either case, it's better than losing money which is what would have happened had we not sold an option.
3. The stock goes in our original direction we thought and hits our target.
We make money on our initial option we bought, BUT we lose money on the option that we sold. HOWEVER, we will still have a NET profit due to the specifics of the option that we sold (to come next).
As you can see, selling an option when the stock price starts going against you is a great way to give you an advantage in the market.
SPECIFICS ON SELLING AN OPTION:
1. You have to have 2 days that the stock price is going against your direction. It DOES NOT MATTER where the price is trading, it only matter that it's going AGAINST your intended direction. So, if you are close to your target, halfway to your target, or the price immediately goes against you (like in our case) then you SELL an option.
2. You want between 20 - 40 days until expiration left in the option you are selling.
3. You are selling the same type of option. So, if you are in a Call (bullish) option, then you'll sell a Call. If you are in a Put, then you'll sell a Put.
4. You want the Delta of the option that you are selling to be .30/-.30 or less.
5. Open Interest - you won't get an ideal open interest, but as long as there's 100 or more, then you are okay.
That's about it.
EXITING THE SOLD OPTION:
Okay, so after you sell the option, you will exit when 1 of 3 things happens:
1. The stock hits one of your original stops - when this happens, exit your sold option (i.e. buy it back).
2. The stock hits your target - sell your original option you bought and then buy back this sold option.
3. The sold options VALUE falls to around 20% of what you ORIGINALLY SOLD it for. Example: you sold the option for $1.00, once the value gets down to $0.20 (where you can buy it for) then you'll want to buy it back.
A couple of final thoughts before moving onto our trade:
1. If you have a few month's left and the stock is just dragging to get to your target, you may be selling an option every month until you hit your target.
2. There's a specific name for this style of trading: "Diagonal Calendar Spreads" Be sure to look these up. I do them a little different than how they will tell you to do them, but it will give you a good explanation. If you can't find these, then look up "Calendar Spread" then look up "Diagonal Spread" - it's simply a combo of both.
Okay FINALLY onto our specific trade.
So, we obviously had 2 days of the stock price going against us. Once I seen this (you must monitor your trades every trading day), I then knew it was time for me to sell an option. I pulled up my broker's trading screen:
First thing we want 20 - 40 days until expiration, the closest was October with 28 days until expiration.
Remember, I want to sell the same type of option that I bought - this is a bearish play, and I bought a Put option, therefore I need to sell a Put option - which is on the right side of my trading screen.
I now need to find an October Put Option with a Delta of -.30 or less. Obviously it's highlighted in yellow, where the delta is -.19, which is the 25 strike.
The open interest in the October Put 25 Option is 8,509 (wow, that's a ton). So we are good there. On another funny note - look at the volume for today, which is "1" - guess who that "1" is - haha that's us, it was "0" before I sold the option.
Okay, next is what to sell it for - this will be the lower price. I always try to get something in the middle if I can for a better entry price. I actually was able to sell it for $0.45 instead of what they originally had listed ($0.40) - so see, it doesn't hurt to try.
So, now we have the original option that we bought and we have this new option that we sold. Now we simply monitor our positions and look for one of the exits (from above) to happen.
Sorry for the stupidly long post - but you gotta know what to do and why to do it.
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