This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Options Forum: You Can Play With Five Grand

It's All Just Paper Anyway

One thing you might consider is doing some paper trading, whether it be through a mock account with a broker such as OptionsXpress or simply tracking the OptionsAlert Newsletter. This will help you gain a better understanding of what strategies make sense and meet your comfort zone in terms of size and risk, and it will let you see how trades are executed and the impact of costs on returns. I've written previously on the benefits and drawbacks of paper trading.

Finding a Way to Unwind

I enjoyed your article on a ratio spread on Valero. The part I am trying to understand is how to protect against the unlimited risk if the underlier goes too high. In the Valero example, $114 is the break-even point. At what point would you unwind this position and how would you do it?

Thanks,
Tim

Tim, we all unwind in different ways; there's no one right way to trade. This includes both deciding what trades to initiate, and subsequently, how to take a graceful and hopefully profitable exit. Ratio spreads, like the one described in the article you reference, carry potentially unlimited risk, so it's absolutely necessary to devise an exit or stop-loss point.

As the article suggests, I like to use break-even price levels as a first point of reference. In the Valero Energy (VLO) position (a $95/$105 one-by-two call spread, which is a trade we executed in the OptionsAlert model portfolio), the $114.75 break-even point was used as an initial trigger for closing the position. One thing to note is that this price represents break-even at expiration. This means that depending on the time remaining and implied volatility awarded to the options, the position will show a loss before expiration even if the share price is below the break-even point. Because the downside risk is limited to the cost of the spread, and it is a speculative position, I don't find it necessary to initially establish a downside stop-loss level.

One approach that I like to use as expiration draws closer is to tighten the stop to price levels below the break-even, which, if triggered, would still result in a profit. Ultimately, one hopes that the share price gravitates toward the maximum profit point, which in the Valero example would be realized at $105 per share.

Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He appreciates your feedback; click here to send him an email.

To read more of Steve Smith's options ideas take a free trial to TheStreet.com Options Alerts.

2 of 2

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
DOW 17,098.45 +18.88 0.11%
S&P 500 2,003.37 +6.63 0.33%
NASDAQ 4,580.2710 +22.5760 0.50%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs