On a recent Monday morning in MTM’s Group Coaching class, a student trader asked me to look at a trade idea involving Goldman Sachs Group, Inc. (GS). Teaching and examining trade ideas is what the class is all about, so I was more than eager to check it out. The trade idea was a potential bear call spread on GC, so we quickly turned our attention to the chart and considered our options.
GS Bear Call
With the stock trading around $487, this option trader was looking to sell a 502.5/505 bear call for that Friday’s expiration, which was four days away. The credit received would have been about 0.30 ($30 in real terms) with the total risk at 2.20 ($220 in real terms). This was derived from the difference in the strikes (505 – 502.50) minus the credit received. Taking a look at the chart below, I noticed that potential resistance was around the $493 level from horizontal resistance that acted as support and resistance in the past.
An Alternative Strategy
Because of the potential resistance at that level, I suggested moving the bear call spread a little lower to generate a bigger credit, which would result in lower risk. We still wanted to have some wiggle room above that potential resistance, so I suggested we move the spread $2.50 lower. We modeled out the 500/502.5 bear call, which produced a credit of 0.45. The total risk was now 2.05. The trade-off here is that the probability went down because the spread was now lower, but the risk/reward got better. But here is the key: We also identified some potential resistance that should increase the odds from a technical aspect.
Trade-Offs in Trading
As I like to say, almost everything in options trading is a trade-off. If you have a good risk/reward, the probabilities of success are smaller and vice versa. In the example above, we reduced the probability on paper. But using technical analysis to guide us, it did not seem that way because of the potential resistance at the $493 level. This example is a good reminder that we should take a closer look at our option trade ideas more often and consider alternatives.
