Potential PG Air Pocket (For What It's Worth)

As I like to point out regularly, successful trading can ultimately be boiled down to a two-step process:

• Spot opportunity
• Exploit opportunity

In other words, first you have to find a situation worth risking money on, then you need to figure out how best to deploy actual capital in order to achieve the best tradeoff between reward-and-risk for that particular situation. This also means that "spotting opportunity" does NOT always mean taking a trade. If the trader deems the opportunity to be "so-so", and/or if a favorable position cannot be adequately established, sometimes the prudent thing to do is to bypass said opportunity and move on to finding the next one.

Bottom line: this trading thing isn't easy.

Take PG for instance. From a seasonal standpoint the 9 trading days after the close on February Trading Day #11 has showed historical weakness. How much weakness? The chart below displays the cumulative price performance for PG during this 9-day period every year since 1962.

In 2021 this period extends from the close on 2/16/21 through the close on 3/1/21.

1962 through 2000 facts and figures include:

Does this rise to the level of "opportunity spotted?" That determination is strictly in the eye of the beholder.

If we look at actual current price action for PG things get even more interesting. The chart below displays PG's recent price action (chart presented Courtesy of AIQ TradingExpert).

Most traders will glance at the chart above and immediately see one of two situations:

• A stock that is breaking down below a key support/resistance price level 
• A stock that is oversold and due for a bounce

Who will be proven correct? Again, that's not for me to say. But for argument's sake, let's assume a trader believes they have spotted an opportunity to play the short side of PG. Now what? 

The most straightforward approach would be to sell short 100 shares of PG. The tradeoff to this approach is also fairly straightforward:

• If PG declines over the next 9 trading days the trader can earn a profit (remember that the median decline during the 43 "down years" was -2.02%)
• Entering this position requires a fair amount of margin money and technically also entails unlimited risk (which a buy stop-loss order at some level above the current price might mitigate to some extent).

Once again, the question is "does this risk/reward tradeoff justify exploiting the opportunity?"

One other possibility is to use options to trade this situation in order to:

• Reduce the amount of capital required
• Reduce the amount of risk

Here there is good news and bad news:

• The good news is that "Yes" there are plenty of options to trade on PG and "Yes" it is possible to commit less capital (than selling short shares of stock) and to limit risk.
• The bad news is that the options in the timeframe we are most interested in trade with significantly wide bid/ask spreads (which can significantly - and negatively - impact one's ability to achieve a favorable reward/risk tradeoff) and are thinly traded.

The screen shot below (Courtesy www.OptionsAnalysis.com) displays a table of PG put options expiring on March 5^th. 

The two key things to note are:

• The relatively wide bid/ask spreads
• The relatively low trading volume in these options

To emphasize: one of the most important skills that you can develop as a trader is the ability to walk away from a "spotted opportunity" if you cannot find an adequate way to "exploit" said opportunity.

For argument's sake, let assume that a trader decides to press on. Our example trade involves buying the Mar05 PG 134 strike price put. Because we are not playing for a huge price movement (remember, the average "down" period saw a median decline of -2.02%) the goal is to get a lot of "deltas" in order to generate point-for-point movement with the underlying stock itself as quickly as possible. 

For the sake of this example was assume that a trader:

• Puts in a limit order at the midpoint of the bid/ask range
• And actually gets filled at that price (Do note that trading volume in this option the prior day was "0")

The particulars appear in the screenshot below and the risk curves in the chart below that.

The two key things to note regarding this example position are:

• The maximum risk (assuming a fill at the bid/ask midpoint) is $658
• The breakeven price is $127.42 (PG was trading at $127.92)

So, is this a worthwhile trade? I make no claims one way or the other. In fact, nothing presented here should be considered as a "recommendation."  The purpose of this piece is NOT to entice you to make a snap decision to jump into a thinly traded option with a wide bid/ask spread on a whim. In fact, it is exactly the opposite. The purpose of this piece is to attempt to help you hone your own ability to:

• Spot opportunity
• Exploit opportunity

Nothing more, nothing less.