What to Do When a Stock Goes Up Too Much [Find Out]
I describe Options360 as having an “unconstrained” approach to trading. In other words, it’s not bound by any single approach such as strictly using credit spreads, iron condors or put and call buying. I pride myself on and promote my Options360 Concierge Trading Service as having a unique advantage of using the strategy that best aligns with my thesis. I have many arrows in my quiver to take advantage of the dynamic nature of options trading.
So, what just happened in our Roku (ROKU) trade pains me greatly. There’s nothing more frustrating than making a good directional call but using a strategy that can lose money if the stock moves “too much.” With many Options360 Concierge Trading Service members asking what was going on, I wanted to share how it’s playing out.
As mentioned here, I established an ostensibly* (note the asterisk) bullish position in ROKU on Monday when the stock was around $203 per share. When I wrote the article on Tuesday, ROKU shares jumped 4% to $217 and I was rubbing hands with glee in anticipation of locking in a quick profit.
On Wednesday, the stock surged some 20% to $255 on news it reached a deal with YouTube to extend its license on carrying the station, and I’m rubbing eyeballs that we might have a loss.
Let’s look at the updated chart before I explain how my bullish position can lose money on a huge move higher.
I initiated the trade on the thesis that it was oversold and would find support around the $200 level and could tally back towards $220.
Based on that thesis, I employed a calendar spread where I bought the 220 strike call expiring on December 23 and sold the 220 strike call expiring this Friday, December 10th, for a $4.90 net debit. The out-of-the-money calendar spread started with a positive delta of 0.20, meaning it would increase in value by $20 for every dollar shares of ROKU increased. More importantly, it had a positive theta of 0.18, meaning it would collect $18 of time decay per day with this amount accelerating as Friday’s expiration of the short leg approached.
I thought it was a well-structured trade position that would benefit if the stock moved up 4% -8% over the next few days. On Tuesday morning, when the stock was trading between $215 and $220, the position was already showing a 20% gain; I sent an Alert outlining the plan to roll the short leg “out and up” to the following day to collect premium, reduce the cost basis and expand profit potential.
This morning, it was looking good in the pre-market as ROKU was trading around the $215 level. Then, the news regarding the YouTube deal crossed the wire, causing the stock to open up some 10% around $235 per share. Suddenly, my bullish position was in trouble because the stock was moving too far too fast!
How can I lose money with that, here comes the asterisk again, an ostensibly bullish position?
Once the calendar spread went nearly in-the-money, both strikes started moving towards intrinsic value; higher delta, less time premium. In other words, the spread I paid $480 for was losing value as calls gained in price but lost their extrinsic value, causing the value of the spread to contract.
I sent an Alert on the open to roll the short leg out to the following week giving us a $2.20 credit. This took our cost/risk down to $260 per spread. Helpful. But, as ROKU continued to surge higher, it hasn’t prevented this position from possibly resulting in a loss.
The max loss will be limited to our new cost basis of $260 (56% of the initial cost). However, there’s still time and maybe shares can pull back below $230 over the next week.
I structured the position to benefit from around 6% over the next few days. I was aware that a large move up or down would be detrimental. But, I liked the setup and probability. Today’s 20% move — the largest in over 3 years including all earnings events, blew my thesis, and the strategy I aligned with it, out of the water.
There’s still time and the possibility that ROKU will retreat back towards our calendar’s strikes and the position could return to profitability. I’m writing this on Wednesday night, and by the time you read it on Friday, we may be back in the green (I’m spending time off the grid with my kids the following few days).
Since I’m usually touting about my great trades and Options360, which is still up 54% for the YTD, I thought it’s only fair to share when a trade goes awry — which clearly doesn’t happen as often as the wins do.
I’m sure I’m having a great time right now on this Friday afternoon, even though I’ll probably have to buy a hat and gloves as my thin Florida blood is leaving me ill-prepared for 20-degree NYC weather. But, I won’t be worried about ROKU. It was a limited-risk position that just endured a worst-case scenario situation.
Maybe the weather will change and I’ll be biking around Central Park… and ROKU will head back towards $220 with the position flipping back to a profit.
Either way, it’s all good. We can’t win them all. But, as history would have it, with the right strategy in place… we can win most of them.
UPDATE FRIDAY MORNING: The weather in NYC is in the 40’s and is supposed to be in the 50’s this weekend, so bikes in Central Park are on the plan…
And ROKU is back down under $230. But, this could still turn into a profitable position for us once again.
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