The last article I wrote on Procter & Gamble (PG) was in the first week of April. In the article, I had focused on making a short-term profit with a Bear Put Spread. For those who go back and read the article, I know I accidentally wrote "call" instead of "put" in the trade line, so that does not have to be mentioned now. I have already suffered for that! The stock is presently trading at $62.49. Here is the original play:
- Buy an October 2012 '65' put (priced at $2.60)
- Sell an October 2012 '62.50' put (priced at $1.72)
- Net Debit to Start: $0.88
- Maximum Profit: $1.62
Reversing the trade on Friday, here is what it came out as:
- Sell the October 2012 '65' (priced at $4.55)
- Buy the October 2012 '62.50' (priced at $3.10)
- Gross Profit on the Trade: $1.45
- Net Profit: ($1.45 profit - $0.88 starting debit) $0.57
- ROI: 64.7%
On paper, this trade makes me look like I made the right decision, but there are three lessons I can learn from watching this trade that I would like to point out.
Choosing the right direction of the stock
When I wrote the article and considered my direction for the stock, I took into account two things; observations from what others wrote and observations about how the stock was moving. I mentioned the article by Ivan Kitov that gave me a sense of direction coming for Procter & Gamble. He mentioned a correction to (60-62) by May. The stock did correct, maybe not as far as Kitov wrote (not yet), but it did correct. So I took into account what he wrote and I also noticed the resistance level that PG just could not seem to punch through. For this reason, I chose a bearish correction play. I happened to get it right this time.
Time of the year
The time of the year is something I always consider when making a play like this. Since we were close to May and the fun little phrase (Sell in May and Go Away) is ever on the trader's mind. This also helped me lean toward a bearish correction play. It just so happened to be right this year.
Initiating plays close to the money
Procter & Gamble is by no means a fast moving stock. So I have learned that my ability to be successful in a trade like this also stems from knowing how to play a stock, and when one has a slow moving stock like this, it is smarter to play as close to the money as possible. Making a trade at the ($62.50 and $60.00) level would have been less risky to start with, but I also would not yet have made a profit.
Time decay is still a factor
In terms of making a profit in May after initiating the options play in April, sheer luck. I had no idea the stock was going to correct as much as it did. I did not anticipate a slowdown in the economic indicators and the huge gap down at the end of April. The stock could have slowly corrected. I am still a firm believer in protection from time decay. I cannot say (what if…I bought the same options for June) that is hindsight and no one can trade with it.
Time decay is helpful in a play like this when it is profitable and harmful when the stock moves against you. Since we are incurring a debit to start trades like this, if it does not move in the direction we want, it immediately becomes harmful. Therefore, I am a firm believer that trading this type of strategy should use longer time periods to give oneself enough time to be right. The nearer one is to time expiration with the stock moving against you, the harder it is to profit.