A strategy analysis: Stops vs owning Calls (or Call Spread)

I have been doing some trade review for 2013 to determine where (not if) there are areas to improve my trading process. This process causes me to evaluate different approaches, back-test some strategies. One thing that I have been thinking about this weekend is how often a Stop is hit – and what could be done as a different approach to avoid that.

There are frequent debates on how/if to use Stops but I wanted to mix things up a little by showing 2 different approaches:

1) long stock with a Stop

2) long Calls (or Call Spread) as the alternative

Let’s go to a Daily chart first on $PEP:

PEP

Now let’s do a comparison to the 2 strategies. First, long stock with a Stop. Using this chart above you would go long the stock here at 83.15 and use the Thursday low of $81.89 as the Stop. This means you are risking $1.26 on the trade. The first target would be $86.73 (the 11/06 Highs).

Now let’s look at the second approach. If you are willing to risk the $1.26 in the 1st strategy then let’s see what kind of Option trade can be done for that same amount. In looking at the December and January Option chains, here are a few choices:

  • Long the Jan/Dec 85 Call Calendar for a $.60 debit. If the December Calls expire, there is no cap to January
  • Long the January 85/87.5 Call Spread for a $.55 debit. Gain is capped
  • Long the January 85 Calls for $.88 debit. Gain is not capped

A few things to chew on when thinking about this:

  • The long stock with a Stop approach could go on for a while and not hit – it could go past the January Option expiration of the Option approach
  • The long stock with a Stop approach could have a Gap down event & miss the Stop – so the loss could be more substantial. Yikes
  • The Option approach has the Risk well-defined

 

2 thoughts on “A strategy analysis: Stops vs owning Calls (or Call Spread)

  1. If you had gone the 1st path – long stock with a Stop – you were stopped out today. Best looking Option trade remains #1: Call Calendar.

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