If you want to avoid such situations while trading, one of the ways to do this is to utilize options in conjunction with your stock trade. For an example of this, I thought I would use my current short position in $MLNX. This position stemmed from my “to fade” list and this is my 2nd trip short since the recent big up move.
Let’s get on to the option piece, here are the specifics:
- I am Short the August 82.50 Put
- I am Long the August 90/100 Call Spread
- This trade was executed on July 20 for free
- Stock consolidates in the $85 to $90 range. Option trade expires with no event.
- Stock continues into the Gap Fill area below but stays above the $82.50 strike. Call spread would have little value (and expire worthless at August expiration, as would the short Put). Short stock position would increase in value.
- Stock breaches the $82.50 strike put and settles at $80 at August expiration. My short stock position would have the gain capped at $82.50. Call Spread expires worthless.
- Stock rebounds to $92.00 at August expiration. I would sell the $90 Call and let the Short $82.50 Put and $100 Call expire worthless. I would have let the trail stop hit on the original short stock position as price rebounded.
- Stock rebounds to $100 at August expiration. I would have let the trail stop hit on the original short stock position as price rebounded and would sell the Call Spread at expiration.
There are likely other scenarios possible, but this gives you an idea of how this Option Collar protects a Short stock position. Add a belt to your shorts. 🙂