One of the stocks on the list is Vermont coffee maker Green Mountain Coffee Roasters (GMCR), a company near and dear to my heart only because I frequent its flagship coffee shop in Waterbury, Vt., several times a week. But more importantly, the stock offers highly liquid options with tight bid-ask spreads.
Last week I decided to trade a weekly bull put spread in GMCR.
I simultaneously sold the GMCR May weekly puts at the 39 strike and bought the 37 puts for a credit of $.30. At the time of the trade, the delta of the 39 strike was .15. This means that the probability of this option being out of the money (the stock price above the put’s strike price) at expiration (or the probability of success) was 85%.
A trade that offers a 15% gain in seven days with a probability of success of 85% is something I’ll trade any day of the week.
When I placed the trade, GMCR was trading at roughly $48, approximately $9 away from my short strike of $39. The expected move that the options market had priced into the stock was $7.20 at expiration. And $40 had acted as an area of strong support for several years.
Thus, the stock would have to move more than 19% to hit my break-even point of $38.70. And the options market told us that there was only a 15% chance of that happening.
Immediately after I placed the trade, the stock rallied. In fact, it closed at $49.52 on Wednesday, which increased the probability of success because the stock would have to fall even further to hit our break-even point. In fact, the chance of success on the trade increased to 88.7%.
Remember, as long as GMCR did not fall below our break-even of $38.70, the trade was a winner. But as we all know by now, GMCR fell prey to a catastrophic fall of close to 50%, resulting in a maximum loss. Just to put the move into perspective, the 30 strike for the May Weekly put option had a delta of 0.01 before the plunge. What does that mean?
Flip a coin 100 times. What are the chances that only one out of the 100 tosses fell as heads? Well, that’s exactly what happened in GMCR. With a delta of 0.01, the market believed that the chance of GMCR moving to the 30 strike was 1% … yes, 1%.
Indeed the move was an anomaly.
And it is the statistical anomalies that lead to losing trades when selling options. But they should be expected every so often because the probabilities provide us with the rate of success. Since our trades have an 80-85% success rate, we know that approximately two out of 10 trades will be losers. However, our losers are typically not max losers like the GMCR trade. In most cases, particularly when limited to ETFs, moves are not as profound, so max losers are infrequent. That’s why I’ve focused on trading ETFs and not stocks within the Options Advantage portfolio.
To keep things simple and focused, I’ve decided to trade only ETFs in the Options Advantage portfolio. However, I will be sending out trade ideas from my list of highly liquid individual stocks roughly three to five times per month. This will provide those of you who prefer more activity the ability to receive more actionable ideas for your own options portfolio.
Let me conclude by saying that losses, while inevitable, are never enjoyable. They hurt and they cost money. But we all know they happen. It’s what you learn from losses that matters most. And what I’ve learned in my 15 years of trading is that you stick with what works.
Don’t let one bad trade throw you off your game. I know that having a statistical edge trading spreads is a sound and profitable system. I also know that it doesn’t work every time — no system ever does. So I don’t plan to change how I go about finding the best edge I can find for my readers. That’s always been my mission with and that will never change.