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25 Jul CMG – The Flying Burrito Continues

Man alive, Chipotle is at it again! Not only does it soar over 80 points post earnings, but it looks like it's continuing the push higher - piggybacking off the latest IPO of $LOCO, the El Pollo Loco restaurant.

Honestly, I'm not really writing this post to discuss the valuation of the restaurant chain, or what the future may hold for the stock price; I am writing about a recent trade that was established in CMG by one of my students. The trade serves as a great example of how one needs to look at trades in an objective way - and not to rely on your broker to give you a fill which makes sense to the rest of the world.

After the recent run-up post earnings, my student decided to take advantage of the higher premium and sell an iron condor after the stock started to establish a range (good job!).

The trade was an iron condor, selling the the Aug1 weekly 680/685 call spread and the 625/630 put spread, for a credit of around .73 or so.

Now some people assume that when you enter an order for an iron condor in your trading platform as one order, that it will fill you with somewhat equal premium on both sides; i.e., the .73 cents for the structure will more or less be split evenly between the call spread and the corresponding put spread.

Here's the kicker: Your broker doesn't care. They don't care where or how you get filled on a trade, as long as you get a fill and pay some commissions. 

The result was that she was filled at a .71 cent credit on the call side and a .02 cent credit on the put side, which made this a bearish trade, not a neutral one as you would expect.

This becomes a big deal later on when you need to make adjustments, because since the trade is all premium on the call side, there is little to no protection on the way up which helps to "finance" your roll to a higher call strike.

In any case, it's my opinion that if you are filled on a trade which was not part of your original intention, it's best to adjust out of it for a small loss or break even.

What my student chose to do is the following:

Cover the call spread side at 1.00 which gave her a .30 loss. Next, cover the short side of the the put spread (the short put) for around .50 (originally sold for $1.26) which gave her a .76 gain. Now, she is left with the long 625 strike put, which she bought for $1.24 and it's now currently .40, which is an .84 cent loss.

So to recap:

-.30 loss, .76 gain, and an -.84 cent loss = -.38 cent total loss.

Since CMG has went straight up+12 points today, she thinks that moving up another 30 points is going to be a stretch, so she is selling the Aug2 700/710 call spread for $1.05

Now the plan here isn't to realize the full premium in this new call spread, rather it is to capture the meat of the pullback in the stock in the next week or so. This pullback will not only help realize the premium in the call spread, but also in the long puts she has left.

The idea here isn't to come out with a win, but a break-even trade or even a small win to help pay for commissions.

This is the power of options - they are flexible enough to realize many different scenarios, especially when you are "wrong".

Happy Trading.

 

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