I recently placed a trade in the OptionsANIMAL weekly animal trade that had dollar cost averaging as an adjustment. I was asked what dollar cost averaging
was and what it looks like. I think most people would understand the term when used with stock trades but I had placed a credit trade.
I rarely trade stocks anymore. I find that option spreads allow me to make more money will less capital, less risk and greater flexibility. Trading options
around stock positions is very lucrative and I feel people just starting out options trading should use trades that have stock ownership as part of the
plan. After trading options for 6 years, I don’t feel the need to own stocks as part of my trading.
One way to dollar cost average is to buy shares of a stock in blocks, not all at once. The idea is that you don’t know exactly what a stock is going to do.
So if you buy a few shares at a time, you could catch a drop in the stock and end up paying less over all for the full position. As an example, say you
want to own 1,000 share of JPM. You believe it will pull back but you are not certain just how far. So once JPM hits $53 you buy 300 shares. It drops to
$52 and you buy another 300 shares. It drops to $51 and you buy another 300 shares. Then it starts to rise and you finish off your position by buying the
last 100 shares at $52. Now if I did my math correctly you have an average price of $51.90. That is better than buying the full position at $53 and
better than trying to buy the full position at $50, which it didn’t hit. That last point is why I sometimes dollar cost average.
I may believe that an equity will drop a bit more or, in the case of my OA weekly trade, it will go up a little more. But if I wait and it doesn’t then I
have no trade at all. My weekly trade has a bit of a ways to go yet but I’m glad I entered a portion of my position when I did. Right now I’m at about a
10% profit in 4 days. Had I waited I would not have that trade on now. I placed a bear call when the equity made a strong move up. It dropped the
next two days and only went up a little on the fourth day which is where we are today. If it had moved up the next trading day I would have added to my
position based on my expectation that the equity was at or near a top and would drop long term.
So what would that look like? I placed a $3 wide bear call for a .65 credit. Had the equity gone up I would have placed an equal number of contracts for a
.85 credit. I would have used the same strikes. That would give me an average credit of .75 and an average risk of $2.25. That is dollar cost average to
me. I started with a risk of $2.35/contract and would end up with an average risk of $2.25. That would result in a return of 33.3% for about 2.5 months. I
can live on that.
So this time I got in on the best possible day , so far. When you trade a lot, that will happen. Another strategy I use on the same equity is selling bull
puts when the equity is below $32. It just doesn’t like being below $32. Sometimes it will go as low as $30 so I dollar cost average and sell bull puts
every day that it is below $32. I catch it at the bottom every time. Of course, only with some of my contracts. By dollar cost averaging I profit a little
if the equity only stays below $32 for a day or a lot if it goes down to $30.
Ken Bailey
OptionsANIMAL Instructor
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