“You got to know when to hold ‘em, know when to fold ‘em” Kenny Rogers, The Gambler
In this article I highlighted an example trade using options on ticker UNG, an ETF that tracks the price of natural gas futures. The trade involved a strategy known as the “bear call credit spread”. This strategy makes money as long as the underlying security remains below the strike price of the call option sold.
Figure 1 displays the outlook for the trade on the initial date. The initial maximum profit potential was $432.
(click to enlarge)Figure 1 – Initial UNG Bear Call Spread (Courtesy www.OptionsAnalysis.com)
Figure 2 displays the example position as of mid-day on 1/19. As you can see the price of ticker UNG shares has fallen from $9.21 to $7.71.
This trade could presently be closed with an open profit of $384, or +19.5%. With the breakeven price of $10.18 a full 32% above the current share price of $7.71, there is no reason why a trader could not simply “let it ride” and wait for some more time decay to push the profit move toward the maximum level of +$432.
However, another alternative way to look at it is this: There is still a month left until expiration in a very volatile market. The original profit/loss tradeoff was:
+$432 / $1968
With $384 of those $432 already earned the current profit/loss tradeoff is:
+$48 of additional profit potential / $2,352 of risk
In other words, the best case scenario from here is to gain another $48 in profit. The worst case scenario is to give back the open profit of $384 plus $1,968.
There is no “correct” answer regarding what to do – “fold ‘em” or “let ‘em ride” – in this situation. But a 19.5% return in 11 days and a sharply oversold market would certainly justify “moving on to greener pastures” in this example