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From the desk of John Thomas The Mad Hedge Fund Trader Friday, June 03, 2011
I am going to use the huge spike down in oil prices this morning triggered by a disastrous May nonfarm payroll report to take profits on my short position in the oil ETF (USO). Specifically, I am selling my August $37 puts at $1.60, the price I am seeing my screen. The (USO) itself is now trading at $38.90.
I initially bought these puts on May 16 for $1.55, when oil was at $100.50. Within days, crude fell to $95.50, boosting the puts to over $2.00, and I should have taken profits there. But I didn’t.
Crude then rebounded to $103, knocking the puts back down to $1.00. This morning, crude is back down to $98.25, a dip of $2.50 since I started this trade, and the puts are essentially unchanged, the profit entirely eaten up by time decay.
That is the lesson with trading these out of the money options. You have to grab the profits when you can before they go up in smoke. The August options only have 2 ½ months left in them, and time decay is starting to accelerate.
For the notional $100,000 portfolio with a 5% weighting, I am booking a profit of $160 (32 X $.05 X 100). This amounts to a 3.2% profit on the position, which adds 3 basis points to your annual return. I’ll be using the next serious rally in oil to reestablish my short, given the dismal economic prospects we are now facing.