Trading Options for Special Situations


A service that one of my friends is following is promoting so called
“Special situation” trades. The three criteria that all Special
Situations have in common is where a temporary market imbalance creates a
scenario where:

A) It would be extremely improbable for us to lose money
B) The return on investment is unusually high
C) A credit spread is determined to be the best vehicle for the trade


1) FAZ has been trading in an up-and-down range from 13 to 18 for the
past three and a half months. To get below 13.00 things have to be
REALLY BULLISH in the financial sector. To take advantage of this
imbalance, he is proposing selling the FAZ Oct 13/12 put spread for about 40
cents, or 68% potential profit.

2) SDS has been reversing right around the 31.00 level for the past four
months. The trade would be to sell SDS Oct 30/29 put spread for
about 34 cents or 51% potential profit.

3) VXX is likely to go up because it's near a significant low and
there's a lot in the coming months for the market to digest. The trade would
be to sell VXX Oct bull 19/18 put spread for 47 cents or 90% potential
profit. [NOTE: 47 cents on 53 cents margin MDW]

4) TBT will go up because it's at the low end of a range and interest
rates just can't go lower. The trade would be to sell TBT Dec 30/29 put spread for 35 cents, or 55% potential profit.

What do you think about this strategy in general?



Hi Kim,

In general, the strategies are fine.  IF YOU WANT TO MAKE DIRECTIONAL PLAYS BASED ON THE INFORMATION PROVIDED, then go for it.   That's the key.  Do you have confidence in the market predictions implied by these trades?  I have no reason to tell you that this service is good or bad, but…

The scenario sounds good.  My only concern is that A) and C) are obviously based on opinion. Thus, you must trust the service's opinion.

1) The FAZ spread: Remember this is a triple weighted ETF, and those come with a built in tendency to trade lower as time passes.  Before jumping into this trade, take a look at the corresponding ETF – i.e., the one that is NOT triple weighted.

The return is excellent.  If you want to take this bet, then it's a good trade.  Recognize that the 13 put is not too far OTM, and my concern is:  What's the trade plan?  Hold to the end (not unreasonable here)?  If not, when would you adjust, and what is the probability of reaching that adjustment price?

2) I don't get this services fascination with leveraged ETFs.

To me, this is NOT a special situation.  It's a market bet based on recent price history.  I'd ask the service: "What makes this a special situation, other than your opinion that it's special?"  The same can be asked for the FAZ spread.

3) VXX is near a recent low?  Based on what?  This is a new product without much history.  Likely to go up?  Who says so?

Look at the chart in the upper 50s.  Couldn't the same argument have been made at that price level?

Kim, these are just a market timer's opinions.  I would want to know if he/she has a good track record before placing bets on his/her opinion.  I see nothing special about any of these trades.  Note: I am not a technical analyst and if you want to bet on chart reading, I wish you well.  I cannot provide any help there – because I do not pay attention to charts.

4) 'Can't get any lower'  Listen to yourself.  Who says it can't?  I have no opinion, but beware of people who tell you this or that cannot possibly occur.  Don't ignore Keynes: "Markets can remain irrational longer than you can remain solvent."

There is no outlandish danger here – other than a) making a market bet based on someone's chart reading, and b) a huge decline.




, , , , , , ,

4 Responses to Trading Options for Special Situations

  1. Filip 09/09/2010 at 4:31 AM #

    Hi Mark,
    “The Rookie’s guide..” was my one of my vacation books this year, it made my 12 hour flight easier 😉
    My interest went especially to the chapter on credit spreads.
    I have been trading vertical debit spreads for some time after learning the hard way that buying naked calls or puts can turn against you pretty fast.
    As M&A are again the talk of the day I would like to know if one can take advantage from such special opportunities using bull put spreads?
    On most occasions when the M&A news has hit the wire the stock has already made a big jump and it’s already too late to profit using a debit spread unless a bidding war starts…
    Having a look at for example the Potash (POT) acquisition:
    POT = 150.47
    Credit spread setup
    P/OCT/145 ask 3.90 (delta -0.34)
    P/OCT/140 bid 3.75 (delta -0.23)
    P/OCT/135 bid 1.35 (delta -0.15) for a 10p spread
    unless the deal would go bust (which I don’t think so) the price of POT would not go down in the next weeks.
    Earnings will be on October 28 – after October 15 expiration.
    Do you have any experience with such trades or tips?
    Is the risk too high in such special situations and it’s best to avoid such opportunities?
    In the meantime I added both credit spreads on my paper trade account to see how they will progress.

  2. Mark Wolfinger 09/09/2010 at 8:28 AM #

    Long flight!
    I have no such experience. I will never sell a spread such as this one for 15 cents. By the way – there is no reason why you should pay the offer and sell the bid. Try for a better price.
    Yes, I know the probability of success is very high and the chances of earning this reward, less commissions, is obviously very high. But people are bidding almost $4 for that 140 put – and there is no reason to believe that those put buyers are stupid.
    There is obviously some chance this stock is under 140 at October expiration. Only you can decide whether the risk/reward feels right to you. I’m far too afraid to make this play.
    If this deal falls through and no white knight appears, this trade will lose almost the full five points.
    This is not a trade I like. However, if the odds appeal to you, there is no reason not to play. The bottom line: Just how good are you at knowing when a deal will either go through, or a backup buyer will be found?
    If you decide to play, please be certain you can afford the loss if it goes against you – and by that I mean, size the trade with respect for the possibility of losing.
    I think there are better ways to make money – but the whole idea behind markets is that different people have different opinions.
    Regards (and good luck)

  3. Edgardo 09/09/2010 at 2:33 PM #

    I think he is talking about put credit spread 145/135 because he says 10p spread, and that one is worth near 2.45
    Also, I think Filip have wrong the part of bid/asks, he is selling the 145, so its price should be from middle to the bid, and buying the 135 near to the ask
    Best Regards

  4. Mark Wolfinger 09/09/2010 at 9:22 PM #

    His numbers are just plain wrong.
    The 140/135P spread is more expensive than the 140/145P spread.
    I hope he writes back with better numbers.