Strategy: Buy n ATM Calls, ≤ 56 DTE
Short n × 100 Shares
Example:
Price Chart: Downtrending
Current IV%: ≤ 20%
IV Rank: ≤ 30
Trade: Buy n ATM call option contracts for each 100 shares of short stock.
Typical Strike Delta:
ATM Long Calls ≈ 0.50 to 0.45
Goals: The shorted stock returns a profit as the stock price drops in value. The long call options hedge a loss if the stock rallies in opposition to the trader’s bearish bias rather than dropping in value.
Manage: When the short stock drops in value by several dollars per share, the trader places a buy-to-cover order to liquidate the short stock for profit. (Shorting a stock returns a profit from a drop in the price of the stock. If the shorted stock drops by $4.00 per share, the trader issues a buy-to-cover order and closes the short stock position for a $4.00 per share profit less brokerage commissions.) The long call options are simultaneously sold to recover any premium that may remain. If the price of the shorted stock rallies, it is closed to minimize loss; the long call options are retained as they move deeper ITM. These options are sold when an acceptable profit in premium income is achieved, or when the price drop stalls and Theta attacks the remaining premium value.
Profit: Close when the short stock returns several dollars per share in profit. If the share price of the stock reverses direction and rallies, buy to close the shorted shares immediately. If the strike of the long calls moves deeper ITM, keep the long calls until the premium achieves a profit. Then sell the remaining premium either for a profit or to minimize a loss.
Loss: The largest potential for a loss is if the share price of the shorted stock begins to rally. Note that the long call’s premium value will drop as the price of the shares of short stock drops. However, the Delta value of each share of stock is 1.00, while the Delta value of an ATM option is 0.50—half that of the stock, itself.