GlaxoSmithKline (GSK) gapped down on earnings on July 23, 2014 breaking below $51.00 demand level.*
Key Levels
Because of the gap, GSK now has overhead supply at $51.00 and potential demand at $48.00. I will use the demand level as target one.
Trade Setup
I will look to take a short position with options if the stock trades below the gap down low at $50.01. I will look to use a Bear Put Spread to capitalize on this trade.
Option Trade
Since I know the stock is broken on the gap down side I will look to take a trade around the key levels with an options play.
• Buy August Monthly $52.50 Puts @ .93 per contract x 100 x 10 contracts = $930.00
• Sell August Monthly $45.00 Puts @ .025 per contact x 100 x 10 contracts = $25.00
• Net Premium outlay is $930.00 -$25.00 = $905.00 (Risk Amount)
Trade Results
The setup triggered on 7/24/2014 and the hold time was four days before it hit the target area at $48.00. I closed the trade and the $52.50 puts were at $2.55 and the $45.00 puts are worthless resulting in a loss of $25.00. The total trade netted $1,620.00.
Bear Put Spread is one way to play options with a low risk profile. A bear put spread involves a net cost or debit, the maximum loss that can arise from this strategy is the cost of the trade plus commissions. The maximum gain that can be made is the difference between the strike prices of the puts less commissions, of course.
Trading Tip
By knowing how stocks react to gaps you can play the direction of the gap with options and free up your capital and have a set risk amount.
* The close at the lows on the day put the stock on my radar for my Swing Newsletter subscribers to get short the next day.
