[12.1] Trading US options for short term

In this article, I chose Citigroup Inc (C) to show you that trading US options can be profitable as long as you keep to a short term period and cut loss tightly to protect your capital.



Chart of  C from May 2011 to December 2011

C was trading @ $37.00 in early June and shot to $42.00 by early July 2011. If you had bought CALL option at strike 42.00, there would be some handsome profits.

Below is a chart of C call option expiry Dec 2011 at strike 42.00 (with superimposed chart of stock C)

From $37.00 to $42.00, C rose $12.00 or 5%
The Call option at strike 42.00 had premium jumped from $1.00 to $3.00 (see red lines)

However, when C retraced and dropped down to about $26.00 by early August, a 38% loss, premium plunged back to $1.00 and stayed below $1.00 ever since (see red circles).

Therefore, do not hold and wait for the stock to rebound because the options lose intrinsic value and also time decay. When the mother stock cannot reach higher again, there would not be any intrinsic value and couple with reducing time value, the premium get so low and becomes worthless.

Another example:-
chart of C call option expiry Dec 2011 at strike 26.00 (with superimposed chart of stock C)

In this example, C was trading between $24.00 to $30.00 in early October 2011.
Say you bought call option expiry Dec 2011 at strike 26.00 and the stock rose from $26.00 to $34.00, an increase of $8.00 or 30% rise, the premium rose from $3.00 to $8.00 or a 160% increase.
Great profits!
However, if you are not careful and forgot to place stops, premium plunged back to $1.00 when the stock price retraced back to $26.00 and below. 

You can also see that the right choice is to choose strike as close to the mother share price as possible in order to gain higher profits.

As this stock C is a downtrending chart, a better way is to trade its PUT option.

chart of C Put option expiry Dec 2011 at strike 26.00  

From the chart above, about end of November, the stock price dropped below $26.00 to about $23.50 but the premium shot up from $1.00 to $3.00! A good profit though the period is very near to expiry.

Again, when the mother price shot up above $26.00 and beyond, premium nose dived to only $0.37!
Always place stops and protect profits and capital. You have to monitor your trades daily so as to capture as much profits and not to lose much. Trading US options can be profitable once you understand the mechanism.


For further learning:-
Check out the lessons on trading options in this blog (see below posting).

Happy trading and merry Christmas!