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Featured Stock: AZPN
JDMMTrades.com Newsletter for January 16, 2008
Major method: Directional options trade
Basis for trade: Double Top
Duration: Near term < 30 days to expiration
Size: At least 3 contracts
Cost: $0.30/share plus $2.85 in fees per contract
Todays' featured stock is AZPN listed on the NASDAQ exchange.
AZPN is in the Computer Software and Services sector and the Business Software and Services sub-sector. My view of the DJI (30) includes several nested Head and Shoulders tops in late 2007 with the breakout down as expected. The sector is quite similar and viewed over mid November 07 to mid-January 08 might be called a double top where I see a right shoulder. Either way, the charts were pointing to a good sized drop.
I bought the Jan 08 15 puts for 0.30 per share or $30 per contract with about 3 weeks to go to Jan 08 expiration. Looking at the chart you'll notice that at the end of the double top there is a very brief upturn or false reversal followed by a steep drop. Did this stock follow the market or move on its own? Since I am trading with the market I don't care but trade that way often as it increases the odds of getting the direction correct.
On Tuesday morning Jan 16, 2008 I sold the puts for $1.85, very close to their high point. Why did I sell at that point? First, the DJI was approaching 12,500 which I consider an emotional support level therefore I expected a bounce near that level. The options expired in 4 days making waiting risky, especially with such a nice profit. Most often on such a play I exit in phases selling 1/3 or so in 3 sepearate sales depending on price movement after each sale.
How profitable was this trade? I use 3 cents a share each way as my cost so I paid 0.30 plus 0.06 per share to own and sell AZPN puts which sold for 1.85. That is $1.49 PROFIT on a 36 cent risk.
My calculator says that is 4.14 times my cost. Directional trades frequently have even higher profit ratios with 10 to 1 not that rare. You'll need these wins as options trading is clearly a percentages game over the long term.
What does this say about directional options trading?
1. Use it when the market supports the sector and stock direction signals.
2. Be quick to take profits with phasing, as explained in another newsletter, often a good choice. Options can easily experience a huge percentage swing in one day where stocks are less prone to do so.
3. Use a stop loss technique on the stock price. If you buy your option for 1% or 2% of a stock's price that is actually a built in stop loss until the option becomes profitable. This allows you to be a bit looser on your stop loss than if you owned the stock itself.
4. Directional trading is riskier than using hedged plays such as straddles or strangles. You only can profit if the stock moves in your direction. With hedging you can profit in either direction. Note: I don't use spreads as I don't sell options except to close a position.
Chart produced by Worden Bros. TC2007