Subscribers to The Contrarian Edge received this commentary on Saturday, November 22.
“Tiiiiime, why you punish me?” Darius Rucker of Hootie and the Blowfish sang that in 1994. It’s an existential song that many an option trader has sung. One of the most significant disadvantages of options trading is the erosion of extrinsic value over time, measured by theta.
Never fear, options traders and 90’s alt rock fans, for there is an options strategy that limits the impact of time decay. Last week, subscribers to our Vertical Options Trader service scored a 454% profit in just under a month on our recommended Alphabet Class A (GOOGL) November 21, 275-300-strike vertical debit call spread. Unpacking the highlights of this trade underscores the utility of the vertical debit spread.
A vertical debit spread is achieved by buying an at-the-money (ATM) option and selling an out-of-the-money (OTM) option in the same expiration month. The credit received from writing the OTM option offsets the entire cost of purchasing the ATM. Unlike other strategies, the risk is limited to the difference between the costs of the extended leg and the income from the short leg.
When recommended on Oct. 17, Alphabet stock was trading at $251. It’s 50-day moving average was sitting below, while there was a trendline connecting February highs with its September peak posing as a ceiling. GOOGL cleared this by November in the two weeks ensuing the rec.
There was some consolidation to start November, but that was broken this week, and we closed out 50% (first half) of the debit spread with the stock trading at $291.74, for a partial gain of 300%. Then on Wednesday, Warren Buffett’s big Berkshire stake bombshell sent GOOGL above $300, so we closed the final half of the position at $299.34, allowing subscribers to collect an overall profit of 454%.
