Hedge Trade Example -- Update

As an update to the hedge trade plan posted this morning, here are some charts and some actual prices. Because of my self-imposed "no trade" time zone of 10:30 -- 11:45 EST, (I've discovered that I have consistently lost money during that time) I missed the best OEX call trade of the day, but want to show it to you anyway to help illustrate how this type of trading works in real time. Perhaps someone who trades during this time frame would've gotten this trade. I didn't!


OEX 600 calls are priced just right in conjunction with an oversold condition at point #1. Calls sold for $1.05 there. Say you buy 10, total risk is $1,050.00. The market rallies strongly to point #2 and the calls go as high as $2.95. Say you sell 4 for $2.50. You make $1,000 and cover your total remaining risk plus $370.00.

At point #2, even though the market looks great, it still has not reached a 38% retracement of the move down since Monday, 5/02/'11. Point #2 therefore is an ideal spot to hedge the remaining OEX calls with e-mini contracts. You short 3 e-minis, 50% of your calls in case you're wrong, because if you are, the continued premium expansion of the remaining 6 calls would offset the loss in the 3 e-minis.

Price retraces 38% from point #2 to point #3. You cover all 3 for 3 points profit even though the actual move is 4.5 points. You gain $450. You don't add any calls.

Price rallies to point #4 but can't take out the high at point #2. You short 1 e-mini contract. Price falls 6 points to a 62% retracement at point #5. You cover for 4 points, or $200. You still don't add calls.

Price rallies strongly to point #6 and looks great, but you realize it can't take out the highs of point #2 much less even point #4. That's a bearish sign so you short another e-mini, just one, in case you're wrong.

The expectation now is for price to exceed the morning lows at point #1. Say you cover there for 10 point, or $500. You are not greedy.



You have a good cushion of profits and you hang on to the calls, (prices shown on middle chart) but it's clear that price is falling fast and you have lower targets in mind. You do not add to the tranche you currently have. You check the prices for the OEX 595 calls but the prices are way off and the spread is $1.85/$5.00 which is ridiculous.


Instead, you bid for SPY 134 weeklies (prices shown on lowest chart), expiring next Friday 5/6 for $1.10. You are filled for 5 contract. The market keeps going but you are confident that its close to reaching a low. Sure enough a huge TICK burst happens, -1365 ticks, which is sign of a near term exhaustion. You bid for 5 more and are filled at $.95, which corresponds to point #9 on the top chart.

Price bottoms and rallies and you sell into the rally along the way, going completely flat at $1.18, point #2 on bottom chart.

Notice point #3 on the middle chart. Price got to $.45 and then hit $1.00 on the bounce. You sell all 6 remaining OEX calls for $1.00, a $30 loss. But the gains on the SPY calls more than make up for it, in addition to the $1,520.00 from the e-mini trades.

In full disclosure, today was not a great day for me with the OEX because I missed the best call trade of the day. But I did use SPY puts at point #2, SPY calls at point #3, sold them at point #4, sold the puts at point #5 (key mistake) bought more SPY calls thinking we were going much higher then sold them at point #6. I bought the SPY 134 weeklies at point #7 and #9 and sold them all in the bounce up to point #10 where I sold the last and went flat. I simply was not feeling the edge to accumulate based on missing the OEX earlier then not having puts for the implosion.

Even though the OEX portion of this narrative is hypothetical, I've tried to keep it as true as possible to the real-time decisions that I make and what I see during the day. Trading the OEX is never easy, especially when the spreads are too wide such as what happened this afternoon. The best defense is to know when to walk away.