Philip Davis

Options Trader: Friday Outlook

Schase - You have to understand options trading to understand how we play a bubble like oil. It goes up in spurts and comes back down and the strategy we pursue shorting oil stocks is we pick a top and (for example) buy the XOM $90 puts on the 16th with $2K out of $10K allocated at $1.50 per contract (13 contracts). When the position moves 30% against us, which it did just 2 days later, we buy 13 more for $1 ($3,300 invested on 26 contracts).

Since it spiked up to $95.70 on the 21st and we thought it was toppy, we rolled those contracts to the $95 puts for + $1.50 per contract, effectively another double down. That put us in 26 XOM $95 puts for $3,300 + $3,900 = $7,200. Since we rolled to a higher strike we increased our allocation but the next roll (if XOM broke $97.50) would have been to move to July puts ($95s for + $1.20) and sell some June puts ($90s for $1.25) to pay for it.

In this particular case, there was no need as the stock came flying down and made us a nice double, which we got out of yesterday and flipped long to play the bounce back, hoping for another nice run up to short into.

We do this all the time and we play both sides but we very much think the whole thing is a scam so it's easier for us to commit the big money to the downside when a stock runs too high. We have 700 members and that's the kind of trading we teach at PSW. There are oil bulls and bears there and we all get along very well because when one group gets out, it's a great signal for the other group to get back in. As User 14.. says, someone else's captitulation is always a good sign to get in yourself and we have a really good community that helps each other trade.

With options using a good cash management strategy, you can ride a bubble like oil up and up and up and still make a really good return when it slides. We are not long-term holders and generally we allow for a stock to run against us for 3 full months but after 45 days we are generally just trying to get even after flipping to a spread.

Obviously, not too many stocks run straight up for 3 months so we have a pretty high success rate.