Anatomy of a Trade

KMX - Anatomy of a Trade

Anatomy of a Trade

Anyone who has listened to tastytrade for more than a few days has surely heard us say, “Trade small and trade often.” That’s because we are convinced that if your number of occurrences is large enough then the “Law of Large Numbers” will provide you with the best chance to succeed. Implicit in this is the understanding that bad trades happen. You did everything right but things didn’t go your way. We are convinced that even those trades, when properly handled, can often be turned into scratches or small winners. We outline one such trade below. How did we do it?

It should be no big surprise that we were selling premium using a Delta Neutral strategy. We sold an at-the-money (ATM) August $50 Straddle in Carmax, Inc. (KMX) which had a high Implied Volatility Rank (IVR)
for a 4.78 credit on July 7, 2016. The trade went against us right from the start and required defensive adjustments within one week as the stock moved sharply to the upside. We rolled the untested put to the $55 strike, about the current price of KMX. This meant that we were inverted. When we are defending a Strangle that has gone wrong going inverted is our last defensive move but Straddles, by their very nature, change the order of things. One week has gone by and we are short the $50/$55 inverted Strangle. We picked up an additional credit of 1.23 on the roll. Day 18 saw our second adjustment. The stock climbed higher and we rolled our short Put higher too by selling the $55/$57.5 Vertical Put Spread and picked up an additional 0.67 credit. We are still not above breakeven.

Day 28 of the trade came along and we are still down and KMX is around $60. Now we had to roll out in price again but also in time for duration. We rolled the August $57.5 Put to the September $60 Put. We also rolled the Call forward in time. We picked up an additional 2.02 credit on that roll. The final roll was to move everything to October expiration. That roll brought in 2.34 which continued to improve our cost basis. The stock started coming back our way and on day 76 we took off the position. The debit paid was 0.04 less than our total credits. A price chart of KMX with marks noting the time of each roll was displayed and a table was provided which listed each move in detail. While this took time and tied up some capital we have no doubt that this was a better solution than simply exiting the trade.

Watch this segment of Anatomy Of A Trade with Tom Sosnoff and Tony Battista for the important takeaways and the step-by step process showing how we turned an immediate and painful loser into a scratch.

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