During the past several weeks we have been discussing the process of finding and trading a credit spread. We decide to use Activision (ATVI) in our mock trade, as it was showing tendencies that would benefit the use of a bear call spread. When we entered the trade a few weeks ago, ATVI was trading just below $20 and we expected this area would hold as resistance. Last week, ATVI shares fell to $18.77, giving us a minor profit if we got out at that time. However, we felt that resistance would hold and that we would be better off waiting for a healthier profit.

From the beginning of this trade, we talked about having an exit point so that our emotions would not rule our trading decisions. We decided that $21 would be our exit point so that our losses would be cut short in case the trade went against us. Now, this may seem like semantics, but if we say, “exit if $21 is broken,” it could mean different things. Once again, this is where the art of trading comes into play.

Last Friday, ATVI traded through $21 intraday, but closed below this point. On Monday, ATVI closed at $21.18, but showed signs that it may be rolling over. In this case, I waited until the open on Tuesday to see how the stock was reacting. In fact, ATVI fell sharply on the session, closing at $20.39. If ATVI had shot well above $21 and showed signs of further advances, I would have cut my losses at that time. If we had closed the trade near the close on Monday, we would have lost approximately $300. However, let’s continue to track this trade to see how it reacts in the next three weeks. Below is the week-to-week progress of this mock trade:

11/12/02
ATVI Bear Call Spread
ATVI @ 19.97
Buy 10 Dec 22.50 Calls @ 1.00
Sell 10 Dec 20 Calls @ 2.00
Net Credit = 1.00 or $1,000
Max Risk = $1,500
Breakeven = $21

11/19/02
ATVI Bear Call Spread
ATVI @ 18.77
10 Dec 22.50 Calls @ 0.35 (bid)
10 Dec 20 Calls @ 1.20 (ask)
Net Credit = 1.00 or $1,000
Profit/loss = 0.15 or $150
Max Risk = $1,500
Breakeven = $21

11/26/02
ATVI Bear Call Spread
ATVI @ 20.39
10 Dec 22.50 Calls @ 0.55 (bid)
10 Dec 20 Calls @ 1.55 (ask)
Net Credit = 1.00 or $1,000
Profit/loss = 0.00 or $0
Max Risk = $1,500
Breakeven = $21

One question readers may be asking is why we would not currently have a profit, considering the stock is below the $21 breakeven point? The reason is that the breakeven point is figured as of expiration. Until expiration, we have an option we have to buy back that creates a loss unless the stock falls sharply. However, now that we are entering the last three weeks of the option’s life, time value will start to drop fast. But, if ATVI trades ITM, it won’t have as much time value to lose.

Since the stock is at a key juncture, we would want to keep a close eye on its movement. Or, if you don’t have time to follow it, enter a limit order with your broker to get out if the stock moves to a point that you no longer want to be in the trade. Unfortunately for this trade, the stock market got a huge boost last week and this sent the major market indices through resistance. However, after such large gains, stocks may see some profit-taking.


Jody Osborne
Senior Staff Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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