Mosaic Company (MOS) is too popular of a company to short anymore. Our original short call at the June 150 strike was very timely in that it became profitable early. The stock's chart appeared to be turning over so we sold the 140 strike. That proved to be devastating to the already obtained profits on the MOS June options. Then we sold the June 150 Calls in attempt to break even on the position upon expiration of the options. Last Wednesday the stock ran up to 151.45 and then down to 145.52. On Friday, the stock broke above the new technical resistance ($151.45), strike price, cost basis and the max profit stops. If you are still in this part of the trade you should look to come out altogether. One option is to sell the July Calls to pay for the added costs of buying about $3 points higher than the stop. Since there wasn't a specific alert on Friday the return will represent closing out at 153.35 or Friday’s close. The chart below shows that MOS has broken above the 127.2% Fibonacci extension and the 162.80% level is at 162.00. Therefore, we could sell the July 165 Calls with some basic reasoning behind selling more options on a stock that is breaking out and running. Our technical stop would be at the 162.5 level. If we sell the July 165 Call and buy the June 150 Call there will be a net debit of $0.45 per contract for gaining another $15 upside room. For everyone's benefit that is short the June 150 Call I will post the July 165 Call position as manage it. Normally I would just move on to another position.
Just a reminder the P/L stop is set to the underlying security’s price level at which the option cost twice as much as the entry price. Some might think that the one to one ratio is tight but an increase of the risk management to 2 times the initial proceeds could hurt the overall returns of the portfolio. For instance, if we are at 80% probability (we are not this month but overall very close to that success rate) on 10 trades per month and each winning trade profits 10% and each losing trade loses 10% then 8 position make a total 8%. But the net return takes the total (8%) less the losers (2% = 2 losers x 10% loss x 10% position allocation) to equal 6%. If we move the stop loss parameter to twice the max gain then the average loser will lose 20% versus a 10% gain per winning trade. The net result with an 80% probability will still have a net profit but only 4% (8% from the winners less 4% = 2 losers x 20% loss x 10% position allocation). The only benefit is if the added room increased the probability significantly. For instance from a 60% to an 85% probability. Then the result would be on favor of the loser risk management.
With an average return of 10%:
70% Probability: 7% (profits) - 3% (losses) = 4% net
85% Probability: 8.5% (profits) - 3% (losses) = 5.5% net
There is no easy way to determine the best ratio. It is almost a non event since I prefer to use technical levels rather than percentage of loss. Good luck! I will be sending out more July positions today and tomorrow.