Options Management - Snatch the Loot and Scoot

I trade with a market timer that follows the S&P 500. The SPX is an Exchange Traded Fund [ETF] that tracks the S&P 500. In addition to following the SPX as a market timer, I also track every 5% price change relative to the open price whenever there is a new bull or bear signal. Gains of 5% have been frequent over the years; 10% gains occur less frequently and are often accompanied with a pull-back; gains of 15% are infrequent and usually transient.

On November 11th 2008 the market is in a downtrend and the timer indicates a bearish signal at the start of the decline. Starting with Novmber 11 through November 24, here are the closing prices of the SPX along with their percent price change relative to the open on November 11:

11: 898.95, -1.98%

12: 852.30, -7.05%

13: 911.29, -0.64%

14: 873.29, -4.77%

17: 850.75, -7.21%

18: 859.12, -6.30%

19: 806.58, -12.01%

20: 752.44 -17.90%

21: 800.13 -12.73%

24: 851.81 -7.10%.

I employ a "Snatch the Loot and Scoot" money management plan that takes advantage of the stock price excursions.

The Options Trade Management Strategy Described

This "Snatch the Loot and Scoot" strategy is straight forward.

We are going to buy an Out of the Money call [at least $1.00 OTM] with a minimum of 45 days to expiration. If the OTM strike is $1 below the next strike and that strike is a multiple of 5 then take the higher strike. Ex. If the OTM strike would have been $44 then take the $45 strike

a) When the SPX has gained 5% sell 25% of your contracts.

b) When the SPX has gained 10% sell half your remaining contracts and roll the other half to 1 strike Out of the Money.

c) When the SPX has gained 15% sell half your remaining contracts.

Gains without trade management

We are going to buy 16 March contracts of the inverse ETF of the SPX, SDS, for $19.98 on 11/11/2008. This costs $31,968. If we didn't employ any money management strategy, we would have experienced a small gain of $299.20.

Table of SDS and Option Values at Critical Dates

ACTION............. OPEN.........SPX GAIN 5%......SPX GAIN 10%...... SPX GAIN 15%...... CLOSE

DATE............. 11/11/2008.... 11/12/2008.........11/19/2008............ 11/20/2008........11/25/2008

SDS PRICE........... 94.31........ 104.94.................112.94..................... 127.97................ 94.13

MARCH 96 CALL..... 19.98........ 27.30.................... 34.50.............................................. 20.167

MARCH 115 CALL.................................................27.05..........................37.95............... 17.30

Gains employing trade management

Look at what happens if we employ a trade management strategy.

1. On 11/12/2008 the SPX has changed by over 5%. We will sell 4 contracts at 27.30 for a gain of $2,928.00 [400 * (27.30 - 19.98)]; we still have 12 contracts.

2. On 11/19/2008 the SPX has changed by over 10%. We will sell 12 contracts at 34.50 for a gain of $17,420.00 [1200 * (34.50 - 19.98)] and buy 6 March 115 contracts at 27.05; we still have 6 contracts.

3. On 11/20/2008 the SPX has changed by over 15%. We will sell 3 contracts at 37.95 for a gain of $3,270.00 [300 * (37.95 - 27.05)]; we still have 3 contracts.

4. On 11/25/2008, the timer has changed so we sell to close the remaining 3 contracts. We sell 3 contracts at 17.30 for a $2,925 loss [300 * (17.30 - 27.05)].

Summing up the profits gained in steps 1 through 4 above, we show a total option profit of $20,697.00. This represents a gain of 64.74%. This gain was realized by selling contracts at prescribed levels to take advantage of the price move.

This scenario is not unusual. Many times we find that the market goes in our direction. However, before we know that the direction has change, we give back some of our hard-earned profits. By capturing the money when it is available, we turn an OK trade into a great trade.

It is critical for investors to take profits when they present themselves. The concept of adding to a trade as the trade progresses adds considerable risk. In addition, in these volatile markets, it is important to have a money management strategy that reduces risk rather than increasing risk.

My web site, SPXTimer.com is devoted to assisting investors improve their investment performance employing the SPXTimer combined with sound money management. We aim to produce exceptional gains while keeping safety primary. Many of our strategies have been developed especially for IRAs. These strategies show you how to safely profit in both bull and bear markets. Our market timer is unique because it includes market sentiment when calculating the market direction. Article Source: http://EzineArticles.com/?expert=Jay_Leavitt,_Ph.D.