postscript to my KCI trade. Long post. Sorry. I don't post often. When I do, I go on and on.
As I mentioned last week, it was not over yet on KCI. There was a week left to go. Bottom line, is I was able to squeeze out about a $1000 last week for a total gain on this series of trades for a total of about $14,000. But, mainly in the last week I was making a number of adjustments to protect my gains. What I was doing was doing primarily was going in and out long underlying as the as the PPS approached, hit, exceeded or went below the strike price on the call.
I made a conservative move also which limited my net gains. But, I wanted to eliminate the risk on the downside. Merrill Lynch was rating this stock a buy, they said the trial should be over by last Friday (the last day of trading before expiration) and they expected a win for KCI. But, qualified it saying a loss could send the stock down to $20. It was currently trading at $45. I don't put much into analysts or even consensus opinions (that is one of the reasons I went into options) - even though I do read them before going into a trade. In fact I read more than a few so I know what is going on with the company. It doesn't hurt. The analyst made this statement early in the week and the stock jumped. However, there is no way anyone can predict what a jury will do. Once a jury gets a case it is their case. I knew that. No one had to tell me. And I thought it was stupid for Merrill Lynch to make such a prediction. So obviously I gave it little weight. There was no more news until after trading was over on Friday. The verdict did not come in and deliberations will be postponed until the beginnig of August a jury member takes his or her prepaid vacation in Alaska.
However, as the weekend closed in I didn't know that. And one thing I did agree with that analyst, was if they lose the case the PPS will drop like a rock. Last November, the stock dropped $30.00 in one or two days. My short put stuck at $35. Even if I put in a contingent order to sell short the underlying to cover, if there was no uptick in the fall, I could be hurt bad. So I bought to close the puts at a loss of about $2400. If I hadn't done that, I would have made $2400 more. But, in the same circumstance, I would do it again.
I was at the Denver airport on Friday preparing for my trip back home to Scottsdale. My flight left at at 12:35 PM Mountain Time. The stock was trading a little under 45, the strike price of my short calls. I made a directional decision (directional is not my focus). I had to get on the plane. I figured the jury hasn't come in with a decision at 1:30 PM CT (San Antonio). The market was going to close in an 1.5 hours EST. The CBOE had said, they would suspend trading until after the verdict, at least that is what I heard. Even if they didn't suspend if there was a verdict it takes at least an hour or more to get everyone together. The likelihood of a verdict that day was small. And the likelihood it would be read to have an impact on the market, was even more unlikely. It could happen either way. But, before I got on the plane, I put in a stop of my 5000 shares at 44.30. It was the right decision. The stock closed at $42.60. I am totally out of KCI underlying and options.
Lesson learned. I will do this kind of play again. But, I will avoid a trade that ONE KNOWN event in the short term future wil have such a significant impact on the PPS in either direction. I am looking to do a similar trade for August, (not KCI) but for much less. Much less, maybe 5 or 10 contracts. I was lucky this trade. I am interested to see the results of another trade with a similar strategy, but with less money. I say similar, as it can not be exactly the same because the market will dictate the adjustments I need to make.
Richard, you are right. I looked at a few possibilities with August expirations that have very high IVs with over priced options. I compared selling the straddles as opposed to strangles. Straddles are better. Even though, selling strangles have more length between strikes and therefore an appearance of less risk, the amount of premiums on the straddle makes up for this. A sale of a straddle gives one more room to make adjustments.
To everyone, I realize that selling straddles and strangles with high IVs in the short term is one of the riskiest trades you can make. Most options books say don't do it. You have unlimited downside in both directions. But, once again, one of my main rules of investing for myself is never go naked unless I have the cash to cover with the underlying - either short or long. In fact, I set benchmarks exactly when I will cover ahead of time. I expect that I will have to cover. And once I make an adjustment (cover by going short or long on the underlying), I then set another benchmark when I will make another adjustment - ahead of time. I think you need to plan in advance, because the heat and the stress of the moment, I may make an emotional decision. However, I need to be flexible if circumstances change. But, by and large, I stick to the game plan.
I am close to finishing. I am new with options, hence the title of this thread. But, I am not new to risk management. My career revolves around financial risk management. I have been at it 23 years. I don't want to say who I work for or specifically what I do. That is why I am being very general. I have seen some very smart people, running organizations, making high six figures and others into the low seven figures make stupid decisions. I have seen this happen again and again. I always anticipate worst case in a trade and what steps can I take to avoid the worst case if it moves in that direction. Also, I am almost done with my 30 day trial of the optionvue, and I have purchased the full package. I have to look at a picture (graph).
Last but not least, I have read a lot about options. The two best books I have read or reading is Options as a Strategic Investment by McMillan and Option Volatility & Pricing by by Natenberg. The other books mainly deal with strategies. Strategies are not hard to learn. IV and a clear understanding of the Greeks is essential, in my opinion and more difficult to learn. But, I think I have enough books. I am going to focus in on the journals on this site after I finish up Natenberg. Those of you who know what you are doing say things in a couple of sentences that speak volumes.
