Today I am going to take what we learned last time and turn it into a Long Put trading case study to show you exactly how you how to make money with the strategy.
It always feels counter-intuitive to think this way… making money while stock prices go down… but with our program in place and our total confidence in the ability to use options, we’re ahead of those confined to simple buy and hold moves.
Let’s get started with a cool t-shirt idea I’ve got, a slogan that tells everyone out there “I’m about to make some serious money.”
Here’s Our Double-Bagger Set-Up
My cool t-shirt idea is for it to have written on it in big bold letters, “Weird Pays!”
The case study highlighted will be the Federal Express Corp. (“FedEx“; NYSE:FDX) Mar15 180P, which as you all know now that you’re getting more experienced, translates to the FDX March of 2015, $180 strike price Put option.
Buying to Open one contract of this option gives you the right to sell FDX at $180 any time before or up until expiration, which is the 3rd Friday of March. The price to pay for one contract is $4.95, for a total of $495 (plus commissions).
Our case study representation of a filled order for this trade is shown below:
A quick rundown on the chart shows that from late November to the entry day highlighted there is an overhead price area that FDX hits, and then stops going higher. The point at which it resists going any higher is called “Resistance.”
You will also see on the chart the price area where the stock stops going down in price. The point at which this happens is called “Support,” and in this case that support level is $170.
Remember, in order for a Long Put trade to work, the stock must move in the anticipated direction, and do so to the point where the option trade built on that anticipated stock move will increase in value enough to become profitable.
On February 19, FDX looked like it was at resistance. Anticipating a lower price move, we selected a Put option trade. Our target for the stock move was down to the consistent support price of $170. That is an expected price move down of $8.65 ($178.65 -$170).
Now let’s take a look at the Risk Graph of this option on February 19th.
The different colored lines represent the value / profit on the option at different price points at different time intervals until expiration. The black line is the profit (+ / -) at expiration. I will look at the black line to ascertain the max value and max risk should it need to be held that long, and should the stock be at the target price of $170 or over $180.
Any price on the stock above $180 at expiration results in a max loss situation on the option, which in our case is $495.
Now keep in mind that you can always establish a plan to sell the option when the stock reaches a different price than $180. Just match up where the price of the stock is with the profit number on the risk graph to see what that amount is.
Time to Cash the Double-Bagger!
Now let’s take a look at how our Long Put case study played out. FDX proceeded to go down in price and eventually hit the $170 price on March 10th, as you can see on the chart. That would be the day to “Sell to Close.”
The price you could sell the option for at minimum is $10.00 or $1,000. Since the original cost was $495, your profit is $505. You would have spent $495 to make a profit of $505, a very impressive 102% ROI – or in my books, a double.
It’s weird but great to make money when the stock goes down, isn’t it?
Say… want to buy one of my t-shirts!?
Until next time…
America’s #1 Trader