Hello, everyone. Welcome to this trade management mini-session. My name is Barbara Armstrong. I'm a coach with Schwab and delighted to be with you today. Today, we're going to talk about an example trading plan on a short put vertical. So I like to make these short and sweet. So I'm going to do exactly that today. So today we're talking short put verticals. I invite you to follow me in the land of X, my handle at barbarmstrongcs4charleschwab. Please know that options carry a high level of risk and are not suitable for all investors. If you would like to trade options through Schwab, you have to apply for option trading privileges and not all will qualify. Also know that you have to take commissions into account when you are trading, especially multi-leg option strategies.
Know that Schwab does not recommend using only technical analysis as a means of investment research. We are going to use the paper money software application on the thinkorswim platform, which is a brilliant way to learn. But there are some nuances and differences. The most important one for us today is that in paper money, we don't ever get to practice a short option being assigned. That can happen in a live account. It will never happen in a paper money account. So, having said all this, let's bring up a word document and let's look at short put verticals and what an example trading plan might be comprised of. Now, if you are not familiar with the short put vertical trading strategy, I will put a link in the show notes down below and at the end of this webcast to the short put vertical getting started with options class.
So, but what we're looking for here when it comes to the four components, general components of a trading plan is what to trade. And when we're looking for what to trade, we are looking for a stock that is bullish. And by that, I mean a stock that is uptrending. Okay. We want the stock to be uptrending or moving to the upside. And some might also say, I would like the sector it's in to be uptrending as well. And the market in general to be uptrending. That way, you're not trying to find a stock that is going against the trend of the sector that it's in or against the market overall. In addition, we might say, well, we don't just want a stock that's uptrending in a sector that's uptrending.
We also want that stock to trade high volumes. And by high volumes, and this is just an example plan, you can make it whatever you want. An example of that might be that you want it to trade at least a million shares per day. And we're talking about an option strategy here. So why do we care about that? Because if the stock trades high volumes, then the option is going to be uptrending. So that's why we're looking for a stock options are likely to trade high volumes as well. And again, what do you mean by that? Well, it could mean an example of, you know, at least 20 times the number of contracts that the investor is planning or the trader is planning on placing.
And, you know, on the Thinkorswim platform, that is noted under the open interest and the volume tabs on the option chain. So we're looking for options that trade high volume. And we may also be looking for options that have a tight bid-ask spread. So what do we mean by that? Well, it means that the difference between the bid price and the ask price is going to be the same. We want that to be less than 10%. And 10% of the, you know, or sorry, I have big here, bid-ask spread of either the bid price or the ask price, for example. Now, in addition, when you get out to the option chain, there are some additional things you may want to look for.
So you may say, well, I'm looking for strike prices that have a delta of between, and this is on the put side, you know, between 20 and 40. You know, so between minus 20 and 40 cents. You know, a delta in that, you know, between 20 and 40. You might also say you're looking for an expiration date in the 20 to 50 day range. I can type today. Honest, I can. And then last but not least, you know, on what to trade, you might say, 'I also want to have a minimum return on risk.' And you might say that minimum, for example, of a 20% return on risk. Now, others might say, or I want a minimum of 1% per day to expiration.
So if you're in the trade for 30 days, the expiration day is 30 days out, you might want a minimum return of 30%. If it's 40 days out, you might want a minimum return of 30% If it's 40 days out, you might want an minimum return of 40%. And, you know, it's your plan, you can make it whatever you want. Now, once you have found a stock that you're looking to trade, when might you consider entering that trade? Well, this is a bullish strategy. And so one might assume that the trader is looking for a bullish entry. And what might a bullish entry be? Well, a bullish entry might be a breakout above a current resistance level. If something's been trading sideways for a while and all of a sudden it breaks out, that might be appealing.
A breakout or a bounce off a support level. Or maybe a bull flag entry with a close above the high of the low day is what CAHOLD stands for. So if you have a bull flag, and again, I'm assuming that you understand the basics of this strategy. Close above the high of the low day. And if we wanted to draw those out, we could. And I tend to find them easiest to understand when I do that. So if we're looking at a stock that, say, was moving to the upside and then started trading in a sideways range. You might say, well, when it's bouncing off a support level. Well, I might consider that an entry, and then I could come down and place my short put vertical trade here.
Now, others might say, well, that could work well, but it could also work well if suddenly it breaks above this resistance level, maybe comes back to retest and bounces. And then a trader might say, OK, I'm going to put my strikes here and in looking to place the trade below a current support level. And in this case, it's old resistance becoming new support. So there's a breakout above resistance, a bounce off a support level or, you know, a bull flag. Something's going up and then starts to go up again. And we have this close above the high of the low day. That could be a third entry. Now, are these the only entries? There are lots of trend reversal patterns, et cetera, that might also, you know, fit the bill.
But these are some examples. OK, so this is when to enter the trade, what we're looking for. How much to trade. So this is also known as position sizing. And, you know, so some might. Have a position size. Based on max loss. And are we getting into a trade assuming that we're going to lose? No. But if we want to be conservative, we know that it is possible for a trade to go against us. And we may want a position size accordingly. And it could be our position size also. Based on, say, 1%. In our trading, a smaller account, we started with a 2% or it could be half of 1% depending. If you have a million dollar account, you might not want to risk more than $2,500 on any one trade of your account size.
Or it could be a finite number. You know, an example, you might say, I don't want to risk more than $500 on any one trade. And you could have a million dollar account. But if you're learning, you might say, hey, this is, you know, what I'm willing to lose on any one trade given I'm still figuring all of this stuff out. OK, so that's position sizing. And then the last one, but certainly not the least important, is when to exit. And so some might set a target and you might say, well, I want to exit when I have 75% or 80% of the max gain. So, if you have sold this short vertical and maybe I received a dollar for selling that vertical, I might say, you know, I'm going to buy it back when it's worth 20 cents.
Then I've got it. If I've got 80% of my max gain, I'd like to take my risk off the table. So that's one example. And if you set that as a target and if in a week, you know, it's at a 70% gain, you might say, hey, you know what, 70% in a week is fantastic. I think I'll take it. Especially if you see a candle that's indicating that, you know, things may be starting, the stock may be setting up to pull back. I've just I've written a few notes. Down here, you may say I am going to exit prior to expiration. So prior to the expiration date, because it is possible to lose more than your theoretical max gain. Let's say if it closed between the strikes and then gap down on the open the following day.
And so this is just a way of enjoying. Ensuring that you're controlling the situation. So you might say prior to expiration date, you know, close out the position. And we just did an example of a trade where I was traveling. I didn't close the trade out prior to expiration and it closed in between the strikes. So it exercised the short strike. And I will put a link. And to that class so that you can see how we managed it. But if you followed that rule, you'd never have to manage that because you would be out prior to expiration. You also might want to exit and just say, 'you know', if it breaks support. Then what do you do? And so some might say, well, I'm I'm going to do nothing.
I've position size based on max loss. And so I'm, I'm going to, unless it's close to expiration, I'm just going to, you know, give it time and hope that it comes back up above my strikes. Some might say, I'm going to close out half the position. So if you had 10 contracts, you might exit five of them. And then you might say, 'you know what', I'm going to close out the entire position. Especially if it's within five to 10 days of expiration because you don't have much time for it to turn itself around. And these are just, these are just guidelines. Another consideration that some traders might have and some traders might do a vertical because they tend to get more credit because volatility is higher prior to earnings.
But they might say, you know what, when I'm going to place the trade, I'm going to place it higher; trade. I'm not, not if earnings is upcoming or a major product announcement or a major event. So that could be a product announcement. It could be, you know, a ruling on whether or not a drug is going to be approved for a biotech stock. So some will say, I am not going to place a trade where between the time I place the trade and the expiration date, there is an earnings or a major event. And they're just trying to be conservative. Others might do that as a part of their trading strategy. And that's totally up to you. So here are the four guidelines.
And then if you want to see that in action, we'll quickly bring up a stock and we're going to bring up me just as our, our example. And with me, we have this bull flag pattern where it's come back for three days. We, it's trading above the high of the low day. And could this $75, $50 be acting as new support? And so could we come to the trade tab? Does it trade more than a million shares a day? Check. If we come out 31 days, is that between 20 and 50? Yes. So check. At this $75 strike, do we have a tight bid ask spread? Check. It's two cents. Do we have lots of volume on these puts? Well, almost 9,000. Check.
And you'll notice there isn't a lot of volume in between because these just became available. But if we did the $75 and the $72,$50, we have a 4 cent spread and thousands of contracts. We're in that delta range of 20 to 40. So we're going to sell. A vertical and it will default to the smallest width. We're going to come down to 72, 50. We'd receive a credit of 73 cents. And keep in mind, we're looking at being in this for 31 days. So if we take 250, which is our risk minus the 73 cents, we're risking $1.77 to make potentially $73 a contract. So $73 divided by $1.77. This is our risk. That's a potential так return on risk of 41% for a trade we'd be in for 31 days.
Does that meet our criteria? Yes? We're going to change our single order, first trigger sequence, right-click, opposite order, put in an example exit. Now, you might say, I want to get out when I have ninety percent one part of my max gain. If we went with 80, we'd make that about 14 cents. Make it good till canceled. I'm not going to worry about position sizing on this one. We're going to hit confirm and send. Again, how much is our theoretical max loss? $178. How much could we make? 72. And then we would go ahead and send that in. There is a transaction fee of $1.30 to place this trade. Send that in. Well, guys, that's a wrap for today. Know that everything that I covered today was for example purposes only. Our example on knee was just that, an example, not a recommendation. And the example trading plan we came up with was also an example, not the definitive IG, but it gives you a framework that you can then customize and make your own. So thank you so much for joining me. Don't forget to follow me in the land of Twitter. Stay tuned. There's lots of great webcasts coming up. Have a great day, everyone. Bye for now.
