Options and Brackets

In a previous article “Pigs get fed and Hogs get slaughtered” I talked about the importance of having a money management plan in place for your more volatile investments.  Actually it makes sense for all investments that have a ready made market.  Sorry, not very viable for real estate owners.

What happens when there is no money management

In the graphic below that was taken from my account today you see what can happen when you don’t take precautions and put a money management plan in place.  Here you will see that I had to sell two options on Pfizer (PFE).  Well, I don’t guess I really had to sell them … they do not expire until January 2020 — however, they were beginning to lose too much money too fast after having minor increases and decreases in value all year.

What happened?

Pfizer is going to merge at least a part of its business with Mylan.  This is from some recent news headlines …

Drug maker Pfizer Inc agreed Monday to spin off its generic drugs business and combine it with generic drug maker Mylan, a move that brings blockbuster treatments Viagra, EpiPen and Lipitor under one umbrella.  The deal will create a giant global seller of lower-priced medicines.”

One of the unpredictable things about options, I have found, is when a company does something funny … like a merger or a stock split (especially a reverse stock split) it can play havoc on the options price.

I did not have profit and loss sales brackets on some of my older options (Pfizer is one of those) that were at a loss when I first set the brackets and this is what took place when I decided to close these two series of contracts out today:

Brackets 1
Figure 1

I know this can be hard to read if your screen is small and you can’t blow it up so let me review it with you.

  • On my four $42 strike price contracts (400 shares) I lost $1,438.10 (and $316.07 of that was today and about $400 was yesterday after the announcement).
  • On my three $45 strike price contracts (400 shares) I lost $864.07.
  • All of these contracts were set to expire on January 17, 2020.
  • I lost 82% and 92% respectively.
  • PIGS GET FED … HOGS GET SLAUGHTERED!

When I first realized these were not working out months ago when they were down only 50% I should have sold them … but … I was thinking Hoggishly (if there is such a word).

What is a good Money Management Technique

I talked about using brackets. This is how a bracket order looks that I set on my Walmart Options on the day I purchased them:

Brackets 2
Figure 2

As you can see, I paid an average cost of about $2.40 per share for the 5 contracts (500 shares) of Walmart Store Stock.  I told the computer that if the price went up by 100% to sell the options and if it went down by a trailing 50% to sell the options.  I will explain trailing in a moment.

A couple of weeks later I checked and the price had not changed much so I left the bracket order alone.

This next one you will see is a little bit different however:

Brackets 3
Figure 3

In this order for 2 contracts on Visa (V), when I originally set it I set it at the average cost of $6.79 per share.  Again, I asked for a profit target of 100% and a trailing stop loss target of 50%.  This means if the price went up immediately to say $13.58 per share it would sell out at the next market price since it hit it’s target price of $13.58 per share.  If it dropped immediately to $3.40 per share it would sell out at the next market price to provide an approximate 50% loss.

But, what would happen if it when up say 70% in value and then dropped back in price?  This is where the “Trailing 50% Stop” takes effect.  The profit target would remain at 100% of the starting price or $13.58 ($6.79 + 100%).  However, if the option went up to $11.54 (up 70%) the new stop price … since it set as trailing would be 50% of the $11.54 or $5.77 for a real net loss of only about 15% and not 50% (e.g. $6.79 – $5.77 divided by $6.79 and carry the decimal two places to the right).  With a trailing stop … it trails the price up but never back down.

Now you will notice in Figure 3 since the price did go up from $6.79 to $10.90 I changed the bracket to provide a 100% return of the $10.90 price (the price would have to go to $21.80 before the option would sell automatically).  And, the trailing stop price at that time would have been $5.45 (which is only 1.34 less than I actually paid or 19.7% potential loss).  Since this option expires in December … if it has not sold by at least the middle of October or a week or so later … I will probably get out of it since options lose more value in the last 45 days of their existence than they do for the entire period before 45 days from expiration.

When this technique really works out …

When the technique works as it is supposed to … this is what you get.  I was checking my email today and came across the this one:

Brackets 4
Figure 4

It is telling me that 3 contracts (300 shares) of PG sold at a price of $8.98 per share and that my account received $2,694 in cash.  How much of this was gain or loss?  Let’s take a look!

Brackets 5
Figure 5

Again, I realize this is hard to read so let me review it with you here.  On June 24, 2019 I purchased 3 contracts of the PG $115 strike with an expiration date of 11/15/2019.  I paid $3.74 per share.  I set my bracket trade at 100% profit (in other words if the price went to $7.48) and 50% Trailing loss.  A couple of weeks later I checked the option and the price had moved up to $4.49 which was higher than I paid for it.  I adjusted my gain to be 100% of the $4.49 (or $8.98) which also moved my stop loss from 50% of $3.74 to 50% of $4.49 — and higher as the price trends up.

I wished I would have checked my brackets yesterday … but I didn’t … so this morning the price hit $8.98 and the option was sold.

BOTTOM LINE:  for being piggish and not hoggish I made a profit of $5.24 per share or $1,571.86 on a total cost of $1,122.04 which works out to a total of 140.09% in a period of 36 days.  Folks that is not shabby, and unlike real estate … I did not have to create a market in which to sell my goods … the market is already there.  Unlike stock … I had leverage like most real estate investors have working for me (and didn’t even have to borrow money to get that leverage).

Leverage adds return … for example:  On 06/24/2019 PG stock closed at $112.33.  Today the stock opened at 119.82 — so, the stock was up a total of 6.87% in 36 days while the option I had increased over 140% in value.

So it’s okay to be a little pig …

Little pig
Figure 6

Just don’t be a big hog …

Domestic pink colored sow graze on pasture
Figure 7

And most importantly … don’t be Stupid and fail to set your money management trades …

Stupid
Figure 8

Y’all have a great week and keep the money moving in the market …

Jerry Nix, Freewavemaker, LLC

 

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