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The Options & Spreads article that follows has been written by an expert who trades successfully for a living. He also offers a course on trading Options & Spreads. For more info on the course click here.

The following article is very educational, informative and well-written.


EPILOGUE: Then What Happened? - Greg Donio

I write this on Saturday, September 14, 1996. On my desk lies a yellow "Save One Dollar" coupon from the Empire State Building. On Monday, July 22, IBM touched a low of 91-7/8 then closed at 92-¼. On Tuesday, low and close both 90-½.

Wednesday, July 24, I first phoned the broker about an hour after the start of trading, to give the stock some time to show some trend. High for the day 92-5/8, low, 89-1/8, currently 90-½. Hmmm. Twice the previous week it had hit lows of 89-¾ and then climbed somewhat. A base? A triple bottom?

Esoterica aside, movement appeared blocked on the down side, bad news for a put-holder. A chance of it rising, more bad news. Nevertheless, in previous days I had rooted for it to sink below 95, then 94, then 93 and a fraction. The 90 looked quite pleasing even with the fraction dangling.

A few minutes later I phoned again. IBM 90-7/8. Then I decided. If it went anywhere at all over 90 and a fraction I would pull out and count my winnings. Of course, it was already just 1/8 of a point from that boundary. Again I phoned. 91-¼. "Sell 10 IBM January 95 put options," I told the broker "at the market to close the position, soon as possible."

Time for a little diversion away from my at-home desk. Within an hour I was in the basement corridor of the Empire State Building, ready to get in line with tourists heading for the 86th floor outdoor observation deck. First I reached for one of the public phones in the hallway. I like the freedom that being an independent trader gives me. My office is in my pockets and my business phone is the nearest touch-tone.

Connecting with the 800 number, I turned over the yellow "Save One Dollar" coupon that the building tour-guide handed out. The broker stated and I jotted, "Sold 10 IBM puts at 9-¼." Only 14 trading days earlier I had paid 5-5/8, a plus-side difference after commissions of $3,524.69. Manhattan in the early afternoon looked silvery from 850 feet up, but the scrap of paper in my pocket felt as dear to me as the photo of the sunfish to the angler who caught it.

But the action continued. The very next day, IBM shot up 10 points, massacring the put options! Most people only say "Why?" when things go wrong and they are bothered. I ask it when things go well. One must know what one did right so one can do it again. How did I happen to tote my gold out of the Black Hills the day before Little Big Horn?

The investment books by Nicholas Darvas that I had read years ago mattered much. He used to advise: As long as a stock keeps going in the right direction, stay with it. When you see it turn around, grab the money and run like a thief. So for a holder of put options, the blockage on the downside was a voice singing, "The Party is Over." The hops upward before the big leap were the same song louder.

Another persuasive item I had in mind was an anecdote from an investment book published earlier this century. A man bought shares for $10,000 and he watched them climb in value to $17,000. Wonderful, he thought. He would pay off all his bills, buy a Packard, buy his wife a fur coat, take an ocean voyage, price some real estate both total and down payment, also.

Then it slipped to $15,000. He decided he would sit firmly until it rebounded. Then $13,000. He could not bring himself to remove anything from his dream-list. Surely the stock would recover if he showed patience and endurance. Finally he lost all the paper profit plus a couple of thousand of capital.

An investment advisor told him afterwards, "Once you mentally spent the money, you felt you could not possibly do with less than $17,000. That did you in." IBM looked wonderful at 90 and a fraction, but when it moved out of that golden frame, I took that as a signal to conclude rather than to await a come-back. So many investors and speculators would have said, "I'll take profit when it gets back to that point on the chart." They should have taken profit earlier when it reached that point then began retreating.

New York University professor of finance George Barrone's advice to short-sellers in the stock market: "Panic early." Also good advice for profit-takers and other traders. The share-holders in Atlantic City casinos who panicked early and sold out with a 10 or 15% loss shed far fewer tears than those who "brazened it out" until those stocks lost more than half their value.

Another entity with me then and with me now is the ghost of W. D. Gann and his utterance, "Go with the trend." After IBM's run-up I said to myself, "Such a big move is usually followed by a retracement. The stock will probably give up a hefty part of that gain real soon. Maybe I should position another put spread."

Cynics refer to this attachment-forming as "keeping pets." You feel in your heart that the stock, commodity or option thereof that gave you a profit before will do it again. This feeling is understandable since to the successful investor the company name sounds afterwards like a victory song, splendid and spellbinding. An echo difficult to ignore.

Thus the pet-keeping side of me said, "IBM. Encore!" but there was another side. W. D. Gann spookily arose off of pages I had read and warned, "Don't buck the trend." Yes, this substantial climb by IBM shares was or could be part of a new trend upward. First, I noticed that retracement did not happen. The stock stayed a little over the 100 level.

Then it rose to 105. I wondered, "Is this the ceiling? Is this the time to slip a put spread under it?" Again harbinger-like the voice cautioned me: Against the trend is poison. Gradually the price ascended to 110, then 115. Yesterday, Friday the 13th, it closed at 122-1/8. A lucky day for me, who did not sip the hemlock.

I try for a scientific approach and do not wish to sound like a superstitious daigo, but an occasional ghost in the attic or on the back stairs can help a financial trader mightily.


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