Option Trading School: Winning Walmart Trade Reminds Us to Not Overlook the Nickels and Dimes

Posted by jbrumley on December 15, 2017 12:39 PM

Truth be told, most traders - and new traders in particular - are "whale hunters." In other words, they're aiming to for huge winners, all the time.

There's a certain logic to the way of thinking too, to be fair. As much as we'd like to believe we know how well each trade is going to perform when we enter it, the reality is, we don't. All any trader can really do is take on a position, hope for the best, and let it reach its maximum potential before making an exit. Veteran traders know most trades don't end up being massively profitable, but enough of them do to merit going to the trouble. That's why the 80/20 principle applies in this world too. That is, 80% of your profits come from just 20% of your trades. You just don't know which of your trades are going to be the 20%.

Thing is, too much of anything is still too much, and sooner or later, the proverbial whale hunt can lead to frustration not because you're not finding the occasional huge winner, but because you're overlooking a bunch of nickels and dimes that, when put together, can make a big difference as well.

In other words, while the 80/20 rule applies, the swinging-for-the-fences attitude can ultimately cost you money, as swinging-for-the-fences forces you to take outsized risks with each and every trade.

The alternative: Sometimes a surer thing (there are no guarantees in the trading business) aiming for a modest gain makes more sense than a risky thing that might translate into a massive profit.

In some way - though not all ways - this is what our Afternoon Channel Trader service is built to do... take advantage of small but high-odds moves, using options to augment the return they provide. Our recently-closed winning options trade on Walmart (WMT) makes this point perfectly, and simultaneously illustrates the power of the approach we apply.

First and foremost, know that the specifics of the signals and triggers we use to pick new recommendations for the Afternoon Channel Trader newsletter is proprietary. Still, we are willing to give you enough to make the bigger point that a lot of smaller winners can be just as potent as the rare big winner win the odds of achieving those modest targets are high.

The simplest explanation of the service is, we're aiming to capitalize on the relatively muted ebbs and flows for a stock, using Donchian Channels as our floors and ceilings. Though we're normally momentum traders, meaning we expect a trend to remain in motion (bearish or bullish), many stocks make reliable reversals within the confines of their Donchian envelope. See our Afternoon Channel Trader for more information, as explained by Price in the video here.

Donchian Channels aren't the only technical clue we consider for these trading ideas, but they're a core part of the analysis.

121517-wmt

And Walmart shares recently gave us a near-perfect example of how this tool, and this idea, can yield reliable even if not massive winners.

Take a look below at the daily chart of WMT. Once the skew of the mid-November jump has been smoothed over we can a technical development. Namely, the stock finds a groove within a sideways trading range, which is framed not just by two horizontal lines, but also by a moving average envelope. [Note that neither is a Donchian line. Like we said, we can't divulge all our trade secrets. Were we able to plot them here though, the channel would be even better defined by the Donchian lines.]

The idea is simple enough - we just want to trade the move from one end of the channel to the other. In this case, that's about a two point move.

The entry and exit are both marked on the chart, by the way. We bought the Wal-Mart (WMT) January Monthly (01/19) 92.5 calls (WMT 180119C92.5) at 4.80 on the 8th, as marked by the blue arrow. We sold the position in two tranches, exiting the first half at $5.80 on the 12th, and sold the second part at $6.25 on the 15th. The 28% gain and the 30% gain on the two pieces, collectively, translated into a 29% gain on the position. Not bad for one week, and a relatively small move that most traders wouldn't even bother gunning for.

It's not just a matter of identifying a range-bound stock though... which Walmart clearly is. (It's remained capped at $98 after reaching the upper edge of the range two days ago, and is feeling its way lower again). This is also a matter of picking stocks with options that offer compelling pricing.

The options on WMT shares are relatively cheap, as the stock is (usually) not all that volatile. This means we have a rather high delta - 0.79, or 79 cents, in this case - giving us a fairly big benefit for a fairly modest move. The proverbial X-factor is, calls tend to be cheaper than they theoretically should be when the stock is falling, and a little more expensive than they should be when the stock's on the way up. This extra "juice" makes a difference, while the channel-based approach allows us to step into such trades with confidence.

Bear in mind that the approach doesn't work as well with all stocks. Indeed, that may be the hardest part about this strategy... finding stocks that reliably trade in a range as predicted by our preferred tools, and selecting the right options that offer enough reward for the risk being taken on. That's the value of the Afternoon Channel Trader newsletter. We've turned the idea into a fine art and a fine science.

If you'd like to learn more about this technique, the best way to learn is by doing. Become a subscriber to the Afternoon Channel Trader advisory today, and start getting these trading ideas on a regular basis. The service sends out about two new ideas every week.

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