Priceline- How Did We Make Triple Digit Gains
Published on August 5, 2010
Published on August 5, 2010
Backspread Option Trading Strategy is one of my favorite strategies when it comes to playing large move and when I am not so sure of the direction. I like to play it especially when I am biased about the direction but I don’t want to take unnecessary risk.
I first introduced this spread to OP readers almost 3.5 years back and since then we have done a lot of trades using backspreads. Recent one is how we played Priceline (PCLN) earnings and netted with Several hundred % gains within a day. Here is what I wrote to OPNewsletter members before opening this speculative trade-
I have purchased a PCLN Aug 240/250 Backspread for $1.68 average (Sell 1x Aug 240 and Buy Aug 2x 250), assume this will be 100% before you invest anything.
The maximum loss (roughly $1,125) will be if a) PCLN is at 250 and b) Nothing is done to the trade till expiration. If you would like to know more about backspread, here is the link -> https://www.optionpundit.net/options-essentials/backspread-startegy-for-large-moves
I expect PCLN to move ~10%, and I am directionally biased but I want to minimize my risk and hence playing it via backspread.
The results – PCLN gapped up almost $42!! and continued to move-up throughout the day; the mid quoted price for our $1.68 Backspread was $20.3!! Some members were quick to book profit (which is a good thing to do) and closed it for $16, netting +814% gains on debit or 121% including margins. I sold it for $18.1 as I want to max out profits so closed it leg by leg, but then PCLN just kept on rising all the way to $286!! (If you are not an OPNewsletter member and would like to sign-up, pls click here to sign-up for the waitlist as OPNewsletter subscription is open via invitation only)
Another member played this earnings via Call Debit vertical spread and netted out with +450%. Below is a screen shot of my trades. As you will notice I purchased puts also assuming that PCLN might pullback after rising $50 in a day.
Fantastic returns by any means. But OPNewsletter members include some very experienced traders who would like to know why we chose this strategy (and had to keep $1,000) margins, thus reducing our gains as opposed to verticals. Here is an exchange of words between two OPN Members (I took the liberty to cut & paste it from paid forum) that provides a lot of insights which you may not find elsewhere –
I was running a bit too fast, sold for $16. Well, “only” 814% gain on debit or 121% on margin. Thanks OP!!!!!!!!
OP, I was curious why you preferred the backspread. I understand that the main advantage of the backspread is that you can do it for even money or even credit, so even if you are wrong, you still can exit for breakeven or even small profit. However, in this case, we paid debit, so if PCLN tanked, we would probably lose most of the debit paid. Why is better than say simple bull spread?
In the true spirit of learning while making money, I challenged my friend to think about it again and share what he find. Here are his thoughts-
Well, as you wrote in your original post, backspread has the potential to make money in either direction, as you do it for credit. So even if you are wrong, you can still make money.
But this is not true in our case since we did it for debit. Comparing profits with say 260/280 bull spread that Chak did for slightly higher debit (but no margin requirements), the backspread returned about 800-900% on debit and about 130% on margin, and bull spread returned about 500%. So return on debit was definitely better for backspread. If PCLN went down, both would probably lose most of the debit. I’m not sure what would happen if PCLN went to 250-260 as you expected.
But again, the main point is that in our case backspread lost its main advantage because it was done for debit and not credit.
And there here is the answer from another member who made 450% using verticals. Review for insights and the detailed work he has done before placing the trade. A good example of due diligence.
Allow me to add to this why I did a debit call vertical. I was expecting about a 12% drop in volatility after earnings and only expected a 10% movement, as did OP. If this is your expectations, it paints a different picture. Both trades would have been up about $300 if we went up 10% to $253 (from $230). Based on debit, the backratio would have had a slightly larger percentage gain. Also, our breakevens for today would have been both around PCLN = $242. (Actually, the backratio would have been around $243, the vertical about $241.) But, due to the IV drop, the backratio would have lost money a lot quicker below the $240 level. If we didn’t move at all, the backratio would have incurred a full loss of the debit (-100% of debit), but the vertical would have only lost about 60%. A max loss of the debit would have been down around PCLN=210 for the vertical and 235 (above the closing price!) for the backratio.
So, taking the -12% drop in IV and 10% expected move, I believed the vertical’s risk/reward was more attractive. Both were expected to make ~$300 if correct, but if wrong, the backratio incurred a max loss over much more of the PCLN range.
That said, in the rare case that your 10% expected move turns into a 20% move, the backratio will do considerably better if you got the direction correct.
So as you can see, there was a good reason for doing vertical debit spread and it paid out nicely for the money invested. This is really the true spirit of improving as a trader where you could look at each past trade and think what could have been better, is there something that can be learned. Here is further discussion between the two members-
Well, on hindsight, you could just go with 260 calls for similar debit (about 2.50) and have 900% return. 270 calls would risk only 1.30 and give you 1,300% return. Of course hindsight is always 20/20, but most of those trades would risk only relatively small amount for potential of making few hundred percent.
Thoughts from 2nd member to this-
I believe the analysis was done based on a 10% move (see OP’s original post). The $2.50 260 call would have been worth about $400 assuming a move to 253. Still a good trade, and quite possibly better than the other 2 trades.
As a true option trader, the learning never stops. As someone said, If you think education is expensive, try ignorance. We made real gains on this trade, but the discussion didn’t stop there. I am proud of OPN community as it challenges the thoughts and through those conversations, we discover many more opportunities. Both the members gave me some ideas to think about when placing the trades in future. (If you are not an OPNewsletter member and would like to sign-up, pls click here to sign-up for the waitlist as OPNewsletter subscription is open via invitation only)
Here are my thoughts on why I chose backspread-
I expected a +10% move, but the key difference was that I also wanted to have room for upside what if I am correct and what if there is a huge short squeeze shortly after the positive announcement. A good Backspread would be making money even if the underlying moves against. But here in this trade, as I originally mentioned I was directionally bias but wanted to reduce my exposure while maximize gains if I am correct. What essentially this Backspread did was to purchase a 250 call but financed most of the cost via selling a 240/250 bear call spread. Additionally, PCLN’s intraday moves are also fairly large from a absolute $ perspective and we still had 15 days time left to salvage the trade if needed.
Bottomline– Verticals, straight calls or backspread are all different strategies suited for different option traders. All have a role to play as long as are clear on objective of each one.
Porfitable Trading and Learning