Active-Trader - Market Maker Move - Part 2

Welcome back, Active Traders and Wealth Builders.

In my prior post Market Maker Move I talked about trading earnings reports using Options.  Since then, I've picked up a few of the finer points of this trade, and used them to good effect this past week.  So let's go through what happened and what was learned from the experience.

First recall that we start this trade by getting the "Market Maker Move" from the Thinkorswim platform.  This appears in the upper right on the Trade tab in yellow next to the text MMM. The MMM is essentially the sum of the premium of the at the money puts and calls and is the amount of the move expected up or down from the closing price.

The gist of this trade it to sell a call spread above the market and a put spread below the market.  In both cases, the short strikes are outside the Market Maker Move.  In the above example of BIDU, I sold short the 182.5 calls and bought the 185 calls as protection and sold short the 162.5 puts and bough the 160 puts as protection.  In the graphic above, the short strikes levels are in red, and the long strike levels are in green.

With this trade, you want the stock to close the week inside the short strikes, so you can keep the entire premium collected on the short strikes and take a complete loss on the long strikes.  In this case, I took in a credit of 1.17 for a max loss of 1.33.  I try to keep the credit greater than about 30% of the spread.  30% of 2.5 is 0.83 so this premium was considered healthy and worth taking the trade.

So what happened in this trade?  BIDU reported good numbers and in the after hours session the stock shot up and traded above my short strike at 185.  So this trade looked like it was going to turn into a max loss.   Surprisingly, when the regular session started on Tuesday, the stock traded at about 175 right in the middle of the range - a gift from the trading gods! The stock closed the week inside the MMM so this position went to max profit.

I had a similar situation with First Solar FLSR where the put side of the trade appeared to go to max loss. Unfortunately, this happened during the regular market hours.  So I pulled the trigger and closed this trade out at just about the fair value of the difference between the strikes, essentially locking in a loss on this trade.  Surprisingly, the stock rallied off the lows and ended the week right smack in the middle of the strikes.  Had I done nothing, the trade would have gone to max profit instead of max loss!

Finally, I tried the same trade with DECK and this one did not go as well. The stock opened down below my short strike and traded most of the day down in that range.  I closed the spread for a debit of 1.60 versus the 0.83 cent credit taken to start the trade.  I could have done better had I waited until later in the day.  And that is one of my lessons learned is to give the trade every change to work out before taking a loss.

Lessons Learned

1)  Do this trade only on big, liquid stocks with lots of volume and good projected Market Maker Moves.

2) Trades later in week are better than those early in the week since you benefit more from Theta Decay.

3) Don't do this trade unless you have options expiring that Friday.  Again Theta Decay is our friend and we won't profit from the collapse in Implied Volatility unless those options are expiring and soon.

4) If the trade goes against you, don't be in a hurry to take a loss.  Things can look very ugly for a time, for example DECK traded as low as 68 on Friday before closing at 74!  But there is tremendous underlying pressure for the stock to close within the MMM because the Market Makers themselves are selling naked straddles on these positions and they only profit if the stock expires inside the MMM.

That's all for now, have a great weekend.